Calculating Net Present Value:

1. Calculations of cash inflows (Investments) required and cah inflows after tax
to be generated by the proposed project.
2. Determination appropriate required rate of return. The required rate of retur
n is the cost of capital and which is used to discount cash flows.
3. Calculation of present value of cash inflows at discount rate.
4. Taking the difference between present value of inflows and outflows to arrive
at net present value.
Illustration 1:
The Swarna Co. Ltd is considering the purchase of a new machine. The alternative
machines (A and B) have been suggested. Each having an initial cost of 4,00,000
Earnings after taxation are expected to be as follows.
Year
Cash Inflows
Machine A
Machine B
1
40,000
1,20,000
2
1,20,000
1,60,000
3
1,60,000
2,00,000
4
2,40,000
1,20,000
5
1,60,000
80,000
The company has a target of return on capital of 10% and on this basis you are r
equired to compare the profitability of the machines and state which alternative
s you consider financially preferable.
The following table gives the present value of Rs. 1 due in 'n' of years.
Years
1
2
3
4
5
Present Value
0.909 0.826 0.751 0.638 0.621
at 10%
Solution:
Statement Showing the profitability of the two machines:
Discount
Machine A
Machine B
Years Factor 10%
Cash
Present
Cash
Present
inflow Value
Inflow Value
1
0.909
40,000 36,360
1,20,000
1,09,080
2
0.826
1,20,000
99,120
1,60,000
1,32,160
3
0.751
1,60,000
1,20,160
2,00,000
1,50,200
4
0.683
2,40,000
1,63,920
1,20,000
81,960
5
0.621
1,60,000
99,360
80,000 49,680
5,18,920

5,23,080

Calculation of Net Present Value

Machine A
Machine B
Total Cash Inflows of Present Value
5,18,920
5,23,080
- Cash Outflows (Investment)
4,00,000
4,00,000
1,18,920
1,23,080
Suggestion :
Machine B is preferable than machine A because the NPV is more than Machine A.
Illustation 2:
A form whose cost of capital is 10% considering to mutually exclusive projects X
and Y. The details of which are:
Project A
Project B
Investment
50,000
50,000
Life (Years)
5
5
Cash Flows Before Depreciation and taxes
1 Year
2 Year

20,000
22,000

30,000
27,000

3 Year
4 Year
5 Year

28,000
25,000
30,000

22,000
25,000
20,000

Cash of capitla = 10% and Taxes Rate = 50%

Which product should be accepted under N.P.V method
Solution:
Year
CFBT
1
20,000
2
22,000
3
28,000
4
25,000
5
30,000
Depreciation:

- DEP
10,000
10,000
10,000
10,000
10,000

=
=
=
=
=

= NP
10,000
12,000
18,000
15,000
20,000

- TAX 50% = PAT + DEP

= CFAT
5,000
= 5,000 + 10,000 = 15,000
6,000
= 6,000 + 10,000 = 16,000
9,000
= 9,000 + 10,000 = 19,000
7,500
= 7,500 + 10,000 = 17,500
10,000
= 10,000 + 10,000 = 20,000

50,000 / 5 = 10,000

Calculation of Net Present Value:

Year
CFAT
Discount
P.V
Factor @ 10%
1
15,000
0.909
13,635
2
16,000
0.826
13,216
3
19,000
0.751
14,269
4
17,500
0.683
11,952
5
20,000
0.621
12,420
Total Present Value
65,492
Less Investment
50,000
Nte Present Value
15,492
Project B:
Calculation of CFAT
Year
CFBT
- DEP
= NP
- TAX 50% = PAT
+ DEP
= CFAT
1
30,000 - 10,000 = 20,000 - 10,000
= 10,000 + 10,000 = 20,000
2
27,000 - 10,000 = 17,000 - 8,500
= 8,500 + 10,000 = 18,500
3
22,000 - 10,000 = 12,000 - 6,000
= 6,000 + 10,000 = 16,000
4
25,000 - 10,000 = 15,000 - 7,500
= 7,500 + 10,000 = 17,500
5
20,000 - 10,000 = 10,000 - 5,000
= 5,000 + 10,000 = 15,000
Depreciation:

50,000 / 5 = 10,000

Calculation of Net Present Value

Year
CFAT
Discount
Factor @ 10%
1
20,000
0.909
2
18,500
0.826
3
16,000
0.751
4
17,500
0.683
5
15,000
0.621
Total Present Value
Less Investment
Nte Present Value

P.V
18,180
15,281
12,016
11,953
9,315
66,775
50,000
16,775

Suggestion: Since NPV of project B is higher than Project A. Hence it is recomme

nded for adoption.