Skip to content

CA Final · Advanced Financial Management · Advanced Capital Budgeting Decisions

Bhagirath Pharma will spend ₹10 lakh now on a pilot plant. If the pilot succeeds (probability 0.6), the firm may spend ₹20 lakh more on full-scale production, whose inflows have a present value of ₹50 lakh at that point; the firm will invest only if it is worthwhile. If the pilot fails (probability 0.4), the project is abandoned with no further cash flows. Ignoring the time value of money, what is the expected NPV of the whole project?

The expected NPV is ₹8 lakh. If the pilot succeeds, the second stage adds 50 − 20 = ₹30 lakh, weighted by 0.6 to give ₹18 lakh. The ₹10 lakh pilot cost is incurred with certainty, leaving ₹8 lakh.

  1. A₹8 lakhCorrect
  2. B₹18 lakh
  3. C₹0
  4. D₹2 lakh

Explanation

On success, the second-stage NPV is 50 − 20 = ₹30 lakh, which is positive, so the firm invests. Expected value of stage 2 = 0.6×30 = ₹18 lakh. Deducting the ₹10 lakh pilot cost gives ₹8 lakh. The ₹18 lakh option ignores the pilot cost, and ₹0 wrongly charges the ₹20 lakh on a success-only basis as 0.6×50 − 10 − 20.

Did you get it right without looking?

One question tells you little. A timed set on Advanced Capital Budgeting Decisions shows your real accuracy, how long you take and where you lose marks.

Practise Advanced Capital Budgeting DecisionsFree diagnostic mock

More Advanced Capital Budgeting Decisions questions