Example problem on evaluation of public alternative -1
Example problem on evaluation of public alternative -1
Two
mutually exclusive projects are being considered for investment. Project A1
requires an initial outlay of Rs. 50,00,000 with net receipts estimated as Rs.
11,00,000 per year for the next 8 years. The initial outlay for the project A2
is Rs. 80,00,000 and net receipts have been estimated at Rs. 20,00,000 per year
for the next 8 years. There is no salvage value associated with either project.
Select the project based on BC ratio by assuming an interest rate of 15%
compounded annually.
Given data
Interest
rate = 15%
Project A1:
Initial
investment, P = ₹. 50,00,000
Annual
receipt = ₹. 11,00,000
Life
of the project, n = 8 years
Project A2:
Initial
investment, P = ₹. 80,00,000
Annual
receipt = ₹. 20,00,000
Life
of the project, n = 8 years
Cash flow diagram
Project A1:
Project A2:
Formula used
BC
ratio = Annual equivalent benefits / Annual equivalent costs
Annual
equivalent of initial cost = P (A/P, i, n)
Solution
Project A1:
Annual
equivalent of initial cost = P (A/P, i,
n)
=
50,00,000 (A/P, 15%, 8)
=
50,00,000 (0.2229)
Annual
equivalent of initial cost = ₹. 11,14,500
BC
ratio = equivalent benefits /
Annual equivalent costs
= 11,00,000 / 11,14,500
BC
ratio = 0.9869
Project A2:
Annual
equivalent of initial cost = P (A/P, i,
n)
=
80,00,000 (A/P, 15%, 8)
=
80,00,000 (0.2229)
Annual
equivalent of initial cost = ₹. 17,83,200
BC
ratio = equivalent benefits /
Annual equivalent costs
= 20,00,000 / 17,83,200
BC
ratio = 1.1215
