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CA Final · Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Advanced Financial Management

Case: Godavari Steels Ltd has two mutually exclusive projects, both with a 10% cost of capital. Project P: outlay Rs 10 lakh, PV of inflows Rs 13 lakh. Project Q: outlay Rs 25 lakh, PV of inflows Rs 30 lakh. Capital is not rationed. Which statement is correct?

Choose Project Q because its NPV of Rs 5 lakh exceeds Project P's NPV of Rs 3 lakh. When projects are mutually exclusive and capital is not rationed, the NPV rule maximises shareholder wealth, so the higher profitability index of P does not override it.

  1. AChoose P because its profitability index of 1.30 is higher than Q's 1.20
  2. BChoose Q because its NPV of Rs 5 lakh exceeds P's NPV of Rs 3 lakhCorrect
  3. CChoose P because its outlay is lower
  4. DBoth are equally good since each has positive NPV

Explanation

NPV of P = 13 - 10 = 3 lakh; NPV of Q = 30 - 25 = 5 lakh. For mutually exclusive projects without capital rationing, the higher NPV project is chosen, as it adds more wealth. The profitability index favours P but is a relative measure and is not decisive here.

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