Page 144 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 6: Capital Budgeting

The company uses a 14% required rate of return for discounting cash flows on a before tax basis. Notes
Solution:
( lakhs)

Year PV Factor Cash PV of Cash Cum PV of Cash PV of Cash Cum. PV of
Outflows Outflows Cash Outflows Inflows Inflows Cash Inflows
A
1 0.877 8 7.016 7.016 0 - 0
2 0.769 6 4.614 11.63 14 10.766 10.766
3 0.675 22 14.85 26.48 34 22.95 33.716
4 0.592 13 7.696 34.176 37 21.904 55.62
5 0.519 10 5.19 39.366 22 11.418 67.038

Year PV Factor Cash PV of Cash Cum PV of Cash PV of Cash Cum. PV of
Outflows Outflows Cash Outflows Inflows Inflows Cash Inflows
B
1 0.877 10 8.77 8.77 4 3.508 3.508
2 0.769 7 5.383 14.153 32 24.608 28.116
3 0.675 17 11.475 25.628 26 17.55 45.666
4 0.592 6 3.552 29.18 8 4.736 50.402
5 0.519 0 0 29.18 2 1.038 51.44

For Product B, the present values of the total cash outflows are 29.181akh. At the end of 2 year,
the cumulative present value of cash inflows is 28,116 lakhs and for 3rd year the present value
of cash inflows is 17.550.

BET for Product B= = 2.06 years

For Product A, the present value of total cash outflows is 39.366 lakhs. At the end of 3 year, the
cumulative present value of cash inflows is 33.716 lakhs and for 4th year the present value of
cash inflows is 21.904 lakhs.

BET of Product A = 3 + = 3.26 years

6.4.6 BET versus the Payback Method

Differences

1. BET starts counting time at the start of the project, irrespective of when the cash outflows
occur whereas payback method starts counting time from the initial cash outflow.
2. BET takes account of time value of money when cumulating cash inflows and cash outflows,
whereas payback method ignores the time value of money.
Similarity

1. Both methods ignore cash inflows after the break-even time or the payback period.

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