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CA Final · Advanced Financial Management · Advanced Capital Budgeting Decisions

Narmada Logistics buys a vehicle for ₹1,00,000 and uses a 10% cost of capital. Year-end operating costs and resale values are: Year 1 – cost ₹20,000, resale ₹70,000; Year 2 – cost ₹30,000, resale ₹50,000; Year 3 – cost ₹45,000, resale ₹30,000. Resale is received only if the vehicle is sold at that year's end, and the cycle repeats indefinitely. Discount factors at 10%: 0.9091, 0.8264, 0.7513. Which replacement cycle minimises cost and what is its EAC?

Replacing every 2 years is best, with an EAC of about ₹58,573. The 1-year cycle costs ₹60,000 a year and the 3-year cycle about ₹62,025. The figure ₹1,01,654 is only the present value of the two-year cost, not annualised.

  1. AReplace every 1 year; EAC ₹60,000
  2. BReplace every 3 years; EAC about ₹62,025
  3. CReplace every 2 years; EAC ₹1,01,654
  4. DReplace every 2 years; EAC about ₹58,573Correct

Explanation

1-year: 1,00,000×1.1 + 20,000 − 70,000 = ₹60,000. 2-year: PV = 1,00,000 + 18,182 + 24,792 − 41,320 = 1,01,654; ÷1.7355 ≈ ₹58,573. 3-year: PV = 1,54,243.5; ÷2.4868 ≈ ₹62,025. The 2-year cycle is lowest; ₹1,01,654 is the PV, not the EAC.

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