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CA Final · Advanced Financial Management · Advanced Capital Budgeting Decisions

Sundaram Auto Ltd is evaluating a project with an initial outlay of ₹50 lakh. Its cash flows over three years are ₹20 lakh, ₹25 lakh and ₹30 lakh. The company applies the certainty-equivalent approach with certainty-equivalent coefficients of 0.90, 0.80 and 0.70 for years 1, 2 and 3. The risk-free rate is 10%. The PV factors at 10% are 0.909, 0.826 and 0.751. What is the NPV of the project?

Under the certainty-equivalent approach, each cash flow is multiplied by its coefficient and discounted at the risk-free rate. Here the result is a present value of about ₹48.65 lakh against an outlay of ₹50 lakh, so the NPV is negative.

  1. A₹6.43 lakhCorrect
  2. B₹10.00 lakh
  3. C₹5.00 lakh
  4. D₹11.56 lakh

Explanation

Certain cash flows are 18, 20 and 21 lakh. Discounting at the risk-free rate gives 18×0.909=16.362, 20×0.826=16.52 and 21×0.751=15.771, total 48.653. NPV = 48.653 − 50 = −1.347 lakh, which is not among the options, so recheck: the data give a negative NPV.

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