Risk Analysis and Capital Budgeting
Exercise problems
Q1
The beta company ltd is considering the purchase of a new investment. Two alternative investment
are available (A and B) each costing Rs 1,00,000. Cash inflow are expected to be as follows:
Cash inflow
Years Investment A Investment B
1 40,000 50,000
2 35,000 40,000
3 25,000 30,000
4 20,000 30,000
The company has a target return on capital of 10%. Risk premium rates are 2% and 8%
respectively for investment A and B. which investment should be preferred?
Q2
An enterprise is investing ` 100 lakhs in a project. The risk-free rate of return is 7%. Risk premium
expected by the Management is 7%. The life of the project is 5 years. Following are the cash flows
that are estimated over the life of the project.
Year Cash flows (` in lakhs)
1 25
2 60
3 75
4 80
5 65
CALCULATE Net Present Value of the project based on Risk free rate and also on the basis of Risks
adjusted discount rate.
,Q3
PQR LTD. is considering a project in U.S.A., which will involve an initial investment of US$
1,40,00,000. The project will have 5 years of life. Current spot exchange rate is `60.30
per US $. The risk-free rate in USA is 7% and the same in India is 8%. Cash inflows from the
project are as follows:
Years 1 2 3 4 5
Cash inflows (US $) 18,00,000 24,00,000 30,00,000 50,00,000 60,00,000
Calculate the NPV of the Project using foreign currency approach. Required rate of return on
the Project is 15%.
, Q4
A project involves an outlay of Rs 1,00,000. Its expected cash flow at the end of year 1 is
Rs40,000. There after it decreases every year by Rs 2000. It has an economic life of 6 years. The
certainty equivalent factor is 1-0.05. calculate the net present value of the project if the risk free
rate of return is 10%. Suggest which of the two project should be preferred.
Q5
Due to a considerable risk inherent in a project costing an initial cash flow of Rs 20,000 a firm decides
to use certainty equivalents to evaluate the project. The certainty equivalents have been estimated
to be 0.8, 0.7, 0.6, 0.5, 0.4 in a period of 5 years. The risk- free rate of interest is 10%. The expected
values of cash inflows are given below:
Years Cash inflow
1 5,000
2 8,000
3 4,000
4 6,000
Exercise problems
Q1
The beta company ltd is considering the purchase of a new investment. Two alternative investment
are available (A and B) each costing Rs 1,00,000. Cash inflow are expected to be as follows:
Cash inflow
Years Investment A Investment B
1 40,000 50,000
2 35,000 40,000
3 25,000 30,000
4 20,000 30,000
The company has a target return on capital of 10%. Risk premium rates are 2% and 8%
respectively for investment A and B. which investment should be preferred?
Q2
An enterprise is investing ` 100 lakhs in a project. The risk-free rate of return is 7%. Risk premium
expected by the Management is 7%. The life of the project is 5 years. Following are the cash flows
that are estimated over the life of the project.
Year Cash flows (` in lakhs)
1 25
2 60
3 75
4 80
5 65
CALCULATE Net Present Value of the project based on Risk free rate and also on the basis of Risks
adjusted discount rate.
,Q3
PQR LTD. is considering a project in U.S.A., which will involve an initial investment of US$
1,40,00,000. The project will have 5 years of life. Current spot exchange rate is `60.30
per US $. The risk-free rate in USA is 7% and the same in India is 8%. Cash inflows from the
project are as follows:
Years 1 2 3 4 5
Cash inflows (US $) 18,00,000 24,00,000 30,00,000 50,00,000 60,00,000
Calculate the NPV of the Project using foreign currency approach. Required rate of return on
the Project is 15%.
, Q4
A project involves an outlay of Rs 1,00,000. Its expected cash flow at the end of year 1 is
Rs40,000. There after it decreases every year by Rs 2000. It has an economic life of 6 years. The
certainty equivalent factor is 1-0.05. calculate the net present value of the project if the risk free
rate of return is 10%. Suggest which of the two project should be preferred.
Q5
Due to a considerable risk inherent in a project costing an initial cash flow of Rs 20,000 a firm decides
to use certainty equivalents to evaluate the project. The certainty equivalents have been estimated
to be 0.8, 0.7, 0.6, 0.5, 0.4 in a period of 5 years. The risk- free rate of interest is 10%. The expected
values of cash inflows are given below:
Years Cash inflow
1 5,000
2 8,000
3 4,000
4 6,000
