Capital Budgeting and Inflation

This assignment delves into the complexities of capital budgeting under inflationary conditions. It examines how rising prices influence factors such as depreciation tax shields, cost of capital, and cash flow projections. The focus is on XYZ's car model launch, highlighting the importance of considering inflation when applying discount rates and evaluating project returns in different tax regimes.

Running head: INTRODUCTION TO FINANCIAL MANAGEMENT
Introduction to financial management
Name of the university
Name of the student
Authors note

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INTRODUCTION TO FINANCIAL MANAGEMENT
Task:
Introduction:
The report is prepared to analyze the four models of cars that have been successfully
tested by Research and development of XYZ. Evaluation of all the models are done using several
techniques of capital budgeting such as average annual profits, payback period, return on capital
employed and net present value. Financial performances of all the models are compared by
computing internal rate of return. Profit on tax by XYZ is paid at an annual rate of 30%. Over the
five year of construction, organization claims capital allowances of purchase cost on straight line
basis. The nominal after tax cost of capital and real after tax cost of capital stood at 10% per
year.
Analysis and evaluation of Model I:

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INTRODUCTION TO FINANCIAL MANAGEMENT
Statement showing calcuation For Model 1
Amounts are in "000"
Particulars 0 1 2 3 4 5 Tot
al
Profit before depreciation
and Tax
70 65 40 20 -30
Less:
Depreciation 24 24 24 24 24
Profit Before Tax 46 41 16 -4 -54
Less:
Tax @ 30% 13.8 12.3 4.8 0 0
Profit After Tax 32.2 28.7 11.2 -4 -54
A) Average Annual profit 2.82
B) Initial Investment 120
Return on capital 2%

3
INTRODUCTION TO FINANCIAL MANAGEMENT
Employed

4
INTRODUCTION TO FINANCIAL MANAGEMENT
C) Profit After Tax 32.2 28.7 11.2 -4 -54
Add:
Depreciation 24 24 24 24 24
Less:
Tax paid 0 13.8 12.3 4.8 0
Net Cash flow 56.2 38.9 22.9 15.2 -30
Initial Investment -120
Accumulated cash flow -63.8 -
24.9
-2 13.2 -16.8
Pay back period non
discounted (years)
3.13
Discounting factor @ 10% 0.909
0909
0.82
645
0.75
131
0.68
301
0.620
921
Discounted cash flow 51.09 32.1
5
17.2
1
10.3
8
-
18.63

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INTRODUCTION TO FINANCIAL MANAGEMENT
Accumulated discounted
cash flow
-120 -
68.91
-
36.7
6
-
19.5
6
-
9.17
-
27.80
Payback period
discounted
Nil
D) NPV calculation at
different discounting rate
Discounting rate @0% 1 1 1 1 1
Discounted cash flow 56.2 38.9 22.9 15.2 -30
Total discounted cash
inflow
103.
2
Less:
Initial Investment 120
Net Present value -
16.8
Discounting rate @2% 0.980
3922
0.96
117
0.94
232
0.92
385
0.905
731

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INTRODUCTION TO FINANCIAL MANAGEMENT
Discounted cash flow 55.09
8039
37.3
895
21.5
792
14.0
425
-
27.17
19
Total discounted cash
inflow
100.
937
Less:
Initial Investment 120
Net Present value -
19.0
63
Dicounting rate @4% 0.961
5385
0.92
456
0.88
9
0.85
48
0.821
927
Discounted cash flow 54.03
8462
35.9
652
20.3
58
12.9
93
-
24.65
78
Total discounted cash
inflow
98.6
969
Less:

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INTRODUCTION TO FINANCIAL MANAGEMENT
Initial Investment 120
Net Present value -
21.3
03
Discounting rate @6% 0.943
3962
0.89 0.83
962
0.79
209
0.747
258
Discounted cash flow 53.01
8868
34.6
209
19.2
273
12.0
398
-
22.41
77
Total discounted cash
inflow
96.4
891
Less:
Initial Investment 120
Net Present value -
23.5
11
Discounting rate @8% 0.925
9259
0.85
734
0.79
383
0.73
503
0.680
583

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INTRODUCTION TO FINANCIAL MANAGEMENT
Discounted cash flow 52.03
7037
33.3
505
18.1
788
11.1
725
-
20.41
75
Total discounted cash
inflow
94.3
212
Less:
Initial Investment 120
Net Present value -
25.6
79
Discounting rate @10% 0.909
0909
0.82
645
0.75
131
0.68
301
0.620
921
Discounted cash flow 51.09
0909
32.1
488
17.2
051
10.3
818
-
18.62
76
Total discounted cash
inflow
92.1
989
Less:

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INTRODUCTION TO FINANCIAL MANAGEMENT
Initial Investment 120
Net Present value -
27.8
01
Discounting rate @12% 0.892
8571
0.79
719
0.71
178
0.63
552
0.567
427
Discounted cash flow 50.17
8571
31.0
108
16.2
998
9.65
987
-
17.02
28
Total discounted cash
inflow
90.1
263
Less:
Initial Investment 120
Net Present value -
29.8
74
Discounting rate @14% 0.877
193
0.76
947
0.67
497
0.59
208
0.519
369

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INTRODUCTION TO FINANCIAL MANAGEMENT
Discounted cash flow 49.29
8246
29.9
323
15.4
568
8.99
962
-
15.58
11
Total discounted cash
inflow
88.1
059
Less:
Initial Investment 120
Net Present value -
31.8
94
Discounting rate @16% 0.862
069
0.74
316
0.64
066
0.55
229
0.476
113
Discounted cash flow 48.44
8276
28.9
09
14.6
711
8.39
482
-
14.28
34
Total discounted cash
inflow
86.1
398
Less:

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INTRODUCTION TO FINANCIAL MANAGEMENT
Initial Investment 120
Net Present value -
33.8
6
Dicounting rate @18% 0.847
4576
0.71
818
0.60
863
0.51
579
0.437
109
Discounted cash flow 47.62
7119
27.9
374
13.9
376
7.83
999
-
13.11
33
Total discounted cash
inflow
84.2
289
Less:
Initial Investment 120
Net Present value -
35.7
71
Dicounting rate @20% 0.833
3333
0.69
444
0.57
87
0.48
225
0.401
878

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INTRODUCTION TO FINANCIAL MANAGEMENT
Discounted cash flow 46.83
3333
27.0
139
13.2
523
7.33
025
-
12.05
63
Total discounted cash
inflow
82.3
735
Less:
Initial Investment 120
Net Present value -
37.6
27
E) Net cash flow -120 56.2 38.9 22.9 15.2 -30
Internal rate of return -
17
%

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INTRODUCTION TO FINANCIAL MANAGEMENT
Average annual profit of Model I is computed at 2.82% that takes into account depreciation and rate of
tax paid by company. Average annual profit can be described as the average annual income that is
expected to be generated by any assets of organization. It is a tool that is used by organization while
considering specific investment that is based on net earnings generated in future in relation to initial
investment made. Return on capital employed generated by Model I is computed at 2% that depicts the
efficiency and profitability of capital that has been employed. On other hand, payback period is computed
at 3.13 and net present value is negative for different weights. Furthermore, internal rate of return is also
negative for the given case.
Statement showing calcuation For Model 2
Amounts are in "000"
Particulars 0 1 2 3 4 5 Total
Profit before depreciation and Tax 20 40 30 60 50
Profit on sale of Fixed Assets 5
Less:
Depreciation 19 19 19 19 19
Loss on sale of Fixed assets 0
Profit Before Tax 1 21 11 41 36
Less:
Tax @ 30% 0.3 6.3 3.3 12.3 10.8
Profit After Tax 0.7 14.7 7.7 28.7 25.2
A) Average Annual profit 15.4
B) Initial Investment 95
Return on capital Employed 16%

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INTRODUCTION TO FINANCIAL MANAGEMENT
C) Profit After Tax 0.7 14.7 7.7 28.7 25.2
Add:
Depreciation 19 19 19 19 19
Residual value of fixed assets 5
Less:
Tax paid 0 0.3 6.3 3.3 12.3
Net Cash flow 19.7 33.4 20.4 44.4 36.9
Initial Investment -
9
5
Accumulated cash flow -75.3 -41.9 -21.5 22.9 59.8
Pay back period non discounted (years) 3.48
Discounting factor @ 10% 0.9090
909
0.826
45
0.751
31
0.683
01
0.6209
21
Discounted cash flow 17.91 27.60 15.33 30.33 22.91
Accumulated discounted cash flow -
9
5
-77.09 -
49.49
-
34.16
-3.83 19.08
Pay back period discounted (years) 4.10
D) NPV calcuation at different

15
INTRODUCTION TO FINANCIAL MANAGEMENT
discounting rate
Dicounting rate @0% 1 1 1 1 1
Discounted cash flow 19.7 33.4 20.4 44.4 36.9
Total discounted cash inflow 154.8
Less:
Initial Investment 95
Net Present value 59.8
Dicounting rate @2% 0.9803
922
0.961
17
0.942
32
0.923
85
0.9057
31
Discounted cash flow 19.313
725
32.10
3
19.22
34
41.01
87
33.421
47
Total discounted cash inflow 145.0
8
Less:
Initial Investment 95
Net Present value 50.08
03
Dicounting rate @4% 0.9615
385
0.924
56
0.889 0.854
8
0.8219
27
Discounted cash flow 18.942
308
30.88
02
18.13
55
37.95
33
30.329
11
Total discounted cash inflow 136.2

16
INTRODUCTION TO FINANCIAL MANAGEMENT
4
Less:
Initial Investment 95
Net Present value 41.24
04
Dicounting rate @6% 0.9433
962
0.89 0.839
62
0.792
09
0.7472
58
Discounted cash flow 18.584
906
29.72
59
17.12
82
35.16
9
27.573
83
Total discounted cash inflow 128.1
82
Less:
Initial Investment 95
Net Present value 33.18
18
Dicounting rate @8% 0.9259
259
0.857
34
0.793
83
0.735
03
0.6805
83
Discounted cash flow 18.240
741
28.63
51
16.19
42
32.63
53
25.113
52
Total discounted cash inflow 120.8
19
Less:
Initial Investment 95

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INTRODUCTION TO FINANCIAL MANAGEMENT
Net Present value 25.81
89
Dicounting rate @10% 0.9090
909
0.826
45
0.751
31
0.683
01
0.6209
21
Discounted cash flow 17.909
091
27.60
33
15.32
68
30.32
58
22.912
Total discounted cash inflow 114.0
77
Less:
Initial Investment 95
Net Present value 19.07
7
Dicounting rate @12% 0.8928
571
0.797
19
0.711
78
0.635
52
0.5674
27
Discounted cash flow 17.589
286
26.62
63
14.52
03
28.21
7
20.938
05
Total discounted cash inflow 107.8
91
Less:
Initial Investment 95
Net Present value 12.89
09

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INTRODUCTION TO FINANCIAL MANAGEMENT
Dicounting rate @14% 0.8771
93
0.769
47
0.674
97
0.592
08
0.5193
69
Discounted cash flow 17.280
702
25.70
02
13.76
94
26.28
84
19.164
7
Total discounted cash inflow 102.2
03
Less:
Initial Investment 95
Net Present value 7.203
4
Dicounting rate @16% 0.8620
69
0.743
16
0.640
66
0.552
29
0.4761
13
Discounted cash flow 16.982
759
24.82
16
13.06
94
24.52
17
17.568
57
Total discounted cash inflow 96.96
41
Less:
Initial Investment 95
Net Present value 1.964
11
Dicounting rate @18% 0.8474
576
0.718
18
0.608
63
0.515
79
0.4371
09
Discounted cash flow 16.694 23.98 12.41 22.90 16.129

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INTRODUCTION TO FINANCIAL MANAGEMENT
915 74 61 1 33
Total discounted cash inflow 92.12
87
Less:
Initial Investment 95
Net Present value -
2.871
3
Dicounting rate @20% 0.8333
333
0.694
44
0.578
7
0.482
25
0.4018
78
Discounted cash flow 16.416
667
23.19
44
11.80
56
21.41
2
14.829
28
Total discounted cash inflow 87.65
8
Less:
Initial Investment 95
Net Present value -
7.342
E) Net cash flow -
9
5
19.7 33.4 20.4 44.4 36.9
Internal rate of return 17%

20
INTRODUCTION TO FINANCIAL MANAGEMENT
The above table depicts the case of Model II that involve the calculation of net present
value using different weights. Average annual profit of this particular model is calculated at
15.4% and return on capital employed is stood at 16%. Payback period is calculated at 4.10 and
net present value is positive for all weights except last two weights. Internal rate of return is
recorded at 17%.
Statement showing calcuation For Model 3
Amounts are in "000"
Particulars 0 1 2 3 4 5 Total
Profit before depreciation and Tax 30 40 30 30 20
Less:
Depreciation 17 17 17 17 17
Loss on sale of Fixed assets 0
Profit Before Tax 13 23 13 13 3
Less:
Tax @ 30% 3.9 6.9 3.9 3.9 0.9
Profit After Tax 9.1 16.1 9.1 9.1 2.1
A
) Average Annual profit 9.1
B
) Initial Investment 85
Return on capital Employed 11%
C
) Profit After Tax 9.1 16.1 9.1 9.1 2.1
Add:
Depreciation 17 17 17 17 17
Residual value of fixed assets 0
Less:
Tax paid 0 3.9 6.9 3.9 3.9
Net Cash flow 26.1 29.2 19.2 22.2 15.2
Initial Investment
-
85
Accumulated cash flow -58.9 -29.7 -10.5 11.7 26.9

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INTRODUCTION TO FINANCIAL MANAGEMENT
Pay back period non discounted
(years) 3.47
Discounting factor @ 10%
0.9090
909
0.826
45
0.751
31
0.683
01
0.6209
21
Discounted cash flow 23.73 24.13 14.43 15.16 9.44
Accumulated discounted cash flow
-
85 -61.27
-
37.14
-
22.72 -7.55 1.89
Pay back period discounted (years) 4.50
D
)
NPV calcuation at different
discounting rate
Dicounting rate @0% 1 1 1 1 1
Discounted cash flow 26.1 29.2 19.2 22.2 15.2
Total discounted cash inflow 111.9
Less:
Initial Investment 85
Net Present value 26.9
Dicounting rate @2%
0.9803
922
0.961
17
0.942
32
0.923
85
0.9057
31
Discounted cash flow
25.588
235
28.06
61
18.09
26
20.50
94
13.767
11
Total discounted cash inflow
106.0
23
Less:
Initial Investment 85
Net Present value
21.02
34
Dicounting rate @4%
0.9615
385
0.924
56 0.889
0.854
8
0.8219
27
Discounted cash flow
25.096
154
26.99
7
17.06
87
18.97
67
12.493
29
Total discounted cash inflow
100.6
32
Less:
Initial Investment 85
Net Present value
15.63
19
Dicounting rate @6%
0.9433
962 0.89
0.839
62
0.792
09
0.7472
58

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INTRODUCTION TO FINANCIAL MANAGEMENT
Discounted cash flow
24.622
642
25.98
79
16.12
07
17.58
45
11.358
32
Total discounted cash inflow
95.67
4
Less:
Initial Investment 85
Net Present value
10.67
4
Dicounting rate @8%
0.9259
259
0.857
34
0.793
83
0.735
03
0.6805
83
Discounted cash flow
24.166
667
25.03
43
15.24
16
16.31
77
10.344
86
Total discounted cash inflow
91.10
51
Less:
Initial Investment 85
Net Present value
6.105
07
Dicounting rate @10%
0.9090
909
0.826
45
0.751
31
0.683
01
0.6209
21
Discounted cash flow
23.727
273
24.13
22
14.42
52
15.16
29
9.4380
04
Total discounted cash inflow
86.88
57
Less:
Initial Investment 85
Net Present value
1.885
65
Dicounting rate @12%
0.8928
571
0.797
19
0.711
78
0.635
52
0.5674
27
Discounted cash flow
23.303
571
23.27
81
13.66
62
14.10
85
8.6248
88
Total discounted cash inflow
82.98
12
Less:
Initial Investment 85
Net Present value
-
2.018
8
Dicounting rate @14%
0.8771
93
0.769
47
0.674
97
0.592
08
0.5193
69

23
INTRODUCTION TO FINANCIAL MANAGEMENT
Discounted cash flow
22.894
737
22.46
85
12.95
95
13.14
42
7.8944
04
Total discounted cash inflow
79.36
12
Less:
Initial Investment 85
Net Present value
-
5.638
8
Dicounting rate @16%
0.8620
69
0.743
16
0.640
66
0.552
29
0.4761
13
Discounted cash flow 22.5
21.70
04
12.30
06
12.26
09
7.2369
18
Total discounted cash inflow
75.99
88
Less:
Initial Investment 85
Net Present value
-
9.001
2
Dicounting rate @18%
0.8474
576
0.718
18
0.608
63
0.515
79
0.4371
09
Discounted cash flow
22.118
644
20.97
1
11.68
57
11.45
05
6.6440
6
Total discounted cash inflow
72.86
99
Less:
Initial Investment 85
Net Present value
-
12.13
Dicounting rate @20%
0.8333
333
0.694
44
0.578
7
0.482
25
0.4018
78
Discounted cash flow 21.75
20.27
78
11.11
11
10.70
6
6.1085
39
Total discounted cash inflow
69.95
34
Less:
Initial Investment 85
Net Present value
-
15.04
7

24
INTRODUCTION TO FINANCIAL MANAGEMENT
E
) Net cash flow
-
85 26.1 29.2 19.2 22.2 15.2
Internal rate of return 11%
The above table depicts the net present value, average rate of return, payback period of
Model III. The internal rate of return is recorded at 11% and average annual rate of return is
calculated at 9.1. Return on capital employed is computed at 11% and payback period is
computed at 3.47.
Statement showing calcuation For Model 4
Amounts are in "000"
Particulars 0 1 2 3 4 5 Total
Profit before depreciation and Tax 30 45 75 80 60
Profit on sale of fixed assets 40
Less:
Depreciation 30 30 30 30 30
Loss on sale of Fixed assets 0
Profit Before Tax 0 15 45 50 70
Less:
Tax @ 30% 0 4.5 13.5 15 21
Profit After Tax 0 10.5 31.5 35 49
A) Average Annual profit 25.2
B) Initial Investment 150
Return on capital Employed 17%

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INTRODUCTION TO FINANCIAL MANAGEMENT
C) Profit After Tax 0 10.5 31.5 35 49
Add:
Depreciation 30 30 30 30 30
Residual value of fixed assets 40
Less:
Tax paid 0 0 4.5 13.5 15
Net Cash flow 30 40.5 57 51.5 104
Initial Investment -
15
0
Accumulated cash flow -120 -79.5 -22.5 29 133
Pay back period non discounted (years) 3.44
Discounting factor @ 10% 0.9090
909
0.826
45
0.751
31
0.683
01
0.6209
21
Discounted cash flow 27.27 33.47 42.82 35.18 64.58
Accumulated discounted cash flow -
15
0
-122.73 -
89.26
-
46.43
-
11.26
53.32
Pay back period discounted (years) 4.11
D) NPV calcuation at different

26
INTRODUCTION TO FINANCIAL MANAGEMENT
discounting rate
Dicounting rate @0% 1 1 1 1 1
Discounted cash flow 30 40.5 57 51.5 104
Total discounted cash inflow 283
Less:
Initial Investment 150
Net Present value 133
Dicounting rate @2% 0.9803
922
0.961
17
0.942
32
0.923
85
0.9057
31
Discounted cash flow 29.411
765
38.92
73
53.71
24
47.57
8
94.196
Total discounted cash inflow 263.8
26
Less:
Initial Investment 150
Net Present value 113.8
26
Dicounting rate @4% 0.9615
385
0.924
56
0.889 0.854
8
0.8219
27
Discounted cash flow 28.846
154
37.44
45
50.67
28
44.02
24
85.480
42
Total discounted cash inflow 246.4

27
INTRODUCTION TO FINANCIAL MANAGEMENT
66
Less:
Initial Investment 150
Net Present value 96.46
63
Dicounting rate @6% 0.9433
962
0.89 0.839
62
0.792
09
0.7472
58
Discounted cash flow 28.301
887
36.04
49
47.85
83
40.79
28
77.714
85
Total discounted cash inflow 230.7
13
Less:
Initial Investment 150
Net Present value 80.71
27
Dicounting rate @8% 0.9259
259
0.857
34
0.793
83
0.735
03
0.6805
83
Discounted cash flow 27.777
778
34.72
22
45.24
84
37.85
4
70.780
65
Total discounted cash inflow 216.3
83
Less:
Initial Investment 150

28
INTRODUCTION TO FINANCIAL MANAGEMENT
Net Present value 66.38
31
Dicounting rate @10% 0.9090
909
0.826
45
0.751
31
0.683
01
0.6209
21
Discounted cash flow 27.272
727
33.47
11
42.82
49
35.17
52
64.575
82
Total discounted cash inflow 203.3
2
Less:
Initial Investment 150
Net Present value 53.31
98
Dicounting rate @12% 0.8928
571
0.797
19
0.711
78
0.635
52
0.5674
27
Discounted cash flow 26.785
714
32.28
64
40.57
15
32.72
92
59.012
39
Total discounted cash inflow 191.3
85
Less:
Initial Investment 150
Net Present value 41.38
51