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Question
1.We want a flexible budget because costs are too hard to predict. We need the flexibility to change budgeted costs as input price change. Does a flexible budget serve this purpose? Explain.

2.Indirect method of reporting cash flows from operating can create a erroneous impression about non-cash expenses (such as depreciation). What kind of impression it can create and why is it erroneous.    

3."The effect of price reduction is always to reduce the p/v ratio, to raise the B.E.P. and shorten the MOS." Explain with suitable example.

4.Equipment A has a cost of ` 75,000/- and net cash flow of ` 50,000/- and generate net cash flow of ` 15,000/- per year for six years. The required rate of return of both equipment's is 11 per cent. Calculate the IRR and NPV for each equipment. Which equipment should be accepted?

Answer
A.   1.we want a flexible budget Because costs are too hard to predict. we need the flexibility to Change budgeted costs as input price change. does a flexible budget serve this purpose? explain


A flexible budget is a budget that is a function of one or more levels of activity.  Thus, the budget depends on one or more measures of activity volume rather than being fixed in amount.

Purpose:--The purpose of a flexible budget is to develop an estimate or estimates of cost for one or more levels of activity.  Activity levels are typically measured in terms of activity inputs, levels, or outputs.  Such a budget is flexible in the sense that it depends upon a specified level of activity volume.  Acquisition budgets focus on the costs to be incurred to acquire actual or planned levels of resources.  Labor budgets, purchasing plans, and similar budgets are resource acquisition oriented.  Activity budgets focus on the resources that should be required to maintain activities at specified levels based on expected or desired levels of efficiency.  Production budgets focus on the resources that would be required to produce a specified set of products and services. Like activity budgets, production budgets are necessarily based on assumed levels of efficiency. The idea of a flexible budget is applicable to all three types of budgets.

Temporal issues:--Flexible budgets can be used as ex-ante forecasts of total cost for various levels of activity volume. Or they can be used as ex-post standards of the costs that should have been incurred for various levels of activity volume (measured in terms of input, activity, or output levels).

Context:--Flexible budgets are used in a wide variety of circumstances.  Such budgets are utilized in not-for-profit organizations as well as business firms, for a variety of activities including administrative and service tasks as well as production activities.  Flexible budgets can be used even when there is no functional relationship between activity inputs and outputs.  In such cases activity volume is measured in terms of input levels or other proxy measures of activity.

Approach:--A flexible budget requires an estimate of the relationship between total cost and activity volume.  The form of that relationship depends on the structure of the process for which costs are being estimated.  Some criteria for choosing a measure of volume include:
1.   Causality -- an individual type of cost should be related whenever possible to that activity which causes the cost to vary.  

2.   Independence of activity measure -- to the extent possible, the activity measure should be independent of other influences.  For example, labor or machine hours are independent of changes in prices.

3.   Ease of understanding -- Activity measure units should be easily understandable and obtainable at reasonable expense. Complicated indices of activity volume are best avoided.

4.   Functionality - Activity measures should be functional and thus contribute to organizational goals.  For example, poor performance should not result in a more generous budget for performance evaluation and control purposes.

Practice: the cost behavior assumption that underlies much of current accounting practice is that cost is a simple linear function of volume.  Specifically, it is assumed that

Total cost C = F + vQ, where F represents total fixed cost, v represents the variable cost per unit of activity, and Q represents the level of activity for which the budget is to be constructed.  When there are multiple cost drivers for an activity, then the linear equation is of the form

  Total cost  C = F + v1Q1 + v2Q2  +  + vnQn   (1)

In matrix form, we would write this as

  Total cost C = F + vQ   (2)

Flexible budgeting can be implemented whenever a reasonably strong relationship exists between total cost and some measure of activity volume.  The relationship can be curvilinear or linear.  The important concept is that the budget flexes, in a predetermined manner, with changes in volume.

Measures of Activity
1.   Flexible budgets are sometimes based on measures of activity inputs (e.g., direct labor hours) that indicate the budgeted costs necessary to acquire a given level of resources at specified prices.  These are acquisition budgets, such as might be used to budget for the purchase of raw materials for a specified period.

2.   Flexible budgets are sometimes based on measures of activity (e.g., hours a production line is in operation) to forecast the cost of operating an activity, usually for a given level of input or output (e.g., standard hours allowed for the output achieved).  In constructing such budgets, one must specify the rate at which resources will be consumed to maintain the activity.

3.   Flexible budgets are sometimes based on measures of activity output (e.g., number of units produced during a period). In constructing such budgets, one must specify both the rate at which resources will be consumed to maintain the activity and the rate at which the activity will produce units of output.  Thus, a flexible budget based on output must be based on specified input/output ratios.


  Common uses of flexible budgets include:

1.   to estimate total indirect factory costs at different levels of activity to compute budgeted activity cost rates,

2.   to budget total indirect factory costs at different levels of activity to compute standard activity cost rates,

3.   to estimate total activity costs at different levels of activity to compute budgeted or standard activity cost rates.

4.   to estimate total activity cost for the level of activity achieved for control and performance evaluation purposes,

5.   to forecast total activity costs for cash budgeting purposes,

6.   to forecast activity costs for expense budgeting purposes, and

7.   to forecast total activity costs to forecast earnings under different scenarios.

Budgets for Performance Evaluation
Budgets that are prepared as part of the master budget were based on a predetermined level of activity, The level of activity was most likely sales volume in units. All budgets designed for one level of activity are referred to as static budgets. For planning purposes, static budgets are fine, However, very few companies perform at the exact level of activity (sales volume) that was used to create the static budgets which comprise the master budget. When comparing actual amounts to budgeted amounts, it is important that both activity levels are the same, i.e., the budget must be adjusted so that the amounts in the budget are based on the number of units of activity the segment actually achieved. For example, a manager that produced and sold 500 widgets should be evaluated by comparing the budgeted amounts of revenue and expenses at 500 units with the actual costs. If the static budget is used to compare to actual, the performance comparison is unfair to management.
Budget Variances
Variances exist for primarily three different causes:
1. The budget may have errors in its creation. This can be due to a number of reasons including math computations, relying on wrong data, failing to consider inflation, etc.
2. Conditions may have changed. Economic conditions impact consumer demand, cost of materials, competitive pricing of goods, etc.
3. A manager's job performance may have been very good or very bad. Favorable variances may not always indicate 'good' situations.
Investigating Variances
The management by exception approach requires that only budget variances that are 'material' in amount are investigated. Material is a term from your financial accounting class that means the number is large enough to impact someone's decision. Both favorable and unfavorable variances are investigated if they exceed the materiality 'threshold'. The threshold can be measured in dollars as a designated amount or as a percentage of the budgeted cost. For instance, assume a budgeted cost of $50,000 for labor with a materiality threshold of 1%. The 1% indicates the level for which all variances exceeding that amount should be investigated. The company using this threshold would investigate all favorable and unfavorable variances that exceed $500.The amount used will vary by company.
Why do companies investigate variances? To determine the cause of the variance so it can be fixed if needed.
Flexible Budgets
A flexible budget can be prepared for any level of activity within the relevant range before or after the actual activity is known. Most often a flexible budget is prepared at the end of the accounting period once the activity level is known. The flexible budget should reflect the same volume of units sold/produced as the number actually achieved.
Flexible budgets can be prepared for any of the individual budgets within the master budget. We will focus primarily on performance evaluation of cost center managers and drill down as to the cause of any variances. You will recall that cost center managers are responsible primarily for costs within their division or department. In the case of manufacturing companies, production cost budgets are very important to ensure that costs remain within budget. In preparing flexible budgets for cost centers, we will separate costs based on behavior--variable costs and fixed costs.
Variable cost section:
Budgeted variable cost per unit x actual number of units produced/sold = Flexible budget variable cost amount
Fixed cost section:
Budgeted fixed costs (same as static budget amount)
Static and Flexible Budget Example
Assume that Max, Inc. created its original income production cost budget assuming 1,000 units would be produced. At the end of the month, it was determined that actual production was only 900 units. If we compare the static budget which allows total costs of $6,550 with the actual amounts incurred of $6,320, it appears the manager is $230 under budget, creating a favorable variance (denoted by 'F') Each variance is marked with a U for unfavorable, or an F for favorable.
     Static   Actual      
        Budget   Activity      
Units produced   Unit costs   1,000   900   Variances   U
Variable costs:          
Direct labor   $2.00   $2,000   $1,800   $200    F
Direct materials   $1.50   1,500   1,400   100    F
Factory supplies      $0.25   250   260   10    U
Total variable costs      $3,750   $3,460   $290    F
Fixed costs:          
Depreciation      $2,000   $2,100   $100   U
Occupancy costs      800   760   40    F
Total fixed costs      $2,800   $2,860   $ 60   U
Total overhead costs      $6,550   $6,320   $230    F
These variances are not very meaningful because the manager produced fewer units. We should prepare a flexible budget that shows the amount of costs allowed at the 900 units that were actually produced. The format is the same. We replace the static budget column with the flexible budget amounts and calculate the new variances.
     Flexible   Actual      
        Budget   Amounts   Variances   
Units produced   Unit costs   900   900   -   
Variable costs:          
Direct labor   $2.00   $1,800   $1,800   $ 0    F
Direct materials   $1.50   1,350   1,400   50    U
Factory supplies      $0.25   225   260   35    U
Total variable costs      $3,375   $3,460   $85    F
Fixed costs:          
Depreciation      $2,000   $2,100   $100   U
Occupancy costs      800   760   40    F
Total fixed costs      $2,800   $2,860   $ 60   U
Total overhead costs      $6,175   $6,320   $145    U
Now it appears the production manager spent more than he was allowed to spend at 900 units of activity. If any of the 5 cost amounts have variances that exceed the company's minimum threshold level for investigation of variances, we would need to determine the manager in charge, determine why the variances exist, and hopefully, find remedies for any in need.
Planning With Flexible Budgets
Some companies use flexible budgets as an aid in planning. This is done by selecting several activity levels and creating side-by-side budgets that show the costs allowed for each of these levels of activity. This helps managers who don't want to wait until the end of the period to see how much they were allowed to spend for the level they achieved. For example, we might create comparative budgets for 920, 940, 960 and 980 units so that a manager that produces units between those levels would have a better idea of how he compares to the benchmarks at those levels.



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2.indirect method of reporting cashflows from operating can create an erroneous impression about non-cash expenses(such as depreciation). what kind of impression it can create and why is it erroneous.

Cash Flow Statement Example-Direct and Indirect Method:
Unlike the major financial statements, cash flow statement is not prepared from the adjusted trial balance. The information to prepare this statement usually comes from three sources:
1.   Comparative balance sheets provide the amount of the changes in assets, liabilities, and equities from the beginning to the end of the period.
2.   Current income statement data help the reader determine the amount of cash provided by or used by operations during the period.
3.   Selected transaction data from the general ledger provide additional detailed information needed to determine how cash was provided or used during the period
Preparing the statement of cash flows from the data sources above involves three major steps:
Step 1. Determine the change in cash:
This procedure is straight forward because the difference between the beginning and the ending cash balance can be easily computed from an examination of the comparative balance sheet.
Step 2. Determine the net cash flow from operating activities:
This procedure is complex. It involves analyzing not only the current year's income statement but also comparative balance sheets and selected transitions data.
Step 3. Determine net cash flows from investing and financing activities:
All other changes in the balance sheet accounts must be analyzed to determine their effects on cash.
Cash Flow Statement Example:
A Comprehensive illustration
To illustrate a statement of cash flows we will use the first year of operations for Tax Consultants Inc. The company started on January 1, 2003, when it issued 60,000 shares of $1 par value common stock for $60,000 cash. The company rented its office space and furniture and equipment, and it performed tax consulting services throughout the first year. The comparative balance sheets at the beginning and at the end of the year 2003 appear as follows.
Assets

Cash
Accounts receivable
Total
Liabilities and Stockholder's Equity
Accounts payable
Common stock
Retained earnings
Total   
Dec. 31, 2003
$49,000
$36,000
-----------
$85,000
======
$ 5,000
$60,000
$20,000
---------
$85,000
=======   
Jan. 1, 2003
$-0-
$-0-
---------
$-0-
=====
$-0-
$-0-
$-0-
-------
$-0-
=====   Change Increase/Decrease
$49,000 increase
$36,000 increase


$ 5,000 increase
$60,000 increase
$20,000 increase
The income statement and additional information for Tax Consultation Inc. are as follows.
Tax Consultants Inc.
Income Statement
For the year ended December 31, 2003
Revenue
Operating expenses
Income before income taxes
Income tax expenses
Net income   $125,000
$ 85,000
---------
$ 40,000
$ 6,000
----------
$ 34,000
=======
Step 1: Determine the Change in Cash:
To prepare a statement of cash flows, the first step―determining the change in cash―is a simple computation. The company has no cash on hand at the beginning of the year 2003, but $49,000 at the end of 2003. Thus the change in cash for 2003 was an increase of $49,000
Step 2: Determine Net Cash Flow from Operating Activities:
A usual starting point in determining net cash flow from operating activities is to understand why net income must be converted. Under generally accepted accounting principles, most companies must use the accrual basis of accounting, requiring revenues be reported when earned and that expenses be recorded when incurred. Net income may include credit sales that have not been collected in cash and expenses incurred that may not have been paid in cash. Thus, under the accrual basis of accounting, net income will not indicate the net cash flow from operating activities.
To arrive at net cash flow from operating activities, it is necessary to report revenue and expenses on cash basis. This is done by eliminating the effects of statement transactions that did not result in a corresponding increase or decrease in cash.
The conversion of net income into net cash flow from operating activities may be done through either a direct method or an indirect method as explained in the following discussion.
1.Direct Method:
(also called the income statement method) reports cash receipts and cash disbursements from operating activities. The difference between these two amounts in the net cash flow from operating activates. In other words, the direct method deducts from operating cash receipts the operating cash disbursements. The direct method results in the presentation of a condensed cash receipts and cash disbursements statement.
As directed from the accrual based income statement, Tax consultants Inc. reported revenues of $125,000. However, because the company's accounts receivable increased during 2003 by $36,000, only $89,000 ($125,000 − $36,000) in cash collected on these revenues. Similarly, company reported operating expenses of $85,000, but accounts payable increased during the period by $5,000. Assuming that payable related to operating expenses, cash operating expenses were $80,000 ($85,000 − $5,000). Because no taxes payable exist at the end of the year, the$6,000 income tax expense for 2003 must have been paid in cash during the year. Then the computation of net cash flow from operating activities is as follows:
Cash collected from revenues
Cash payment for expenses
Income before income taxes
Cash payments for income taxes
Net cash provided by operating activities   $89,000
$80,000
---------
$ 9,000
$ 6,000
---------
$ 3,000
======
"Net cash provided by operating activities" is equivalent of cash-basis net income. ("Net cash used by operating activities" would be equivalent to cash-basis net loss)
2 Indirect Method:
(or reconciliation method) starts with net income and converts it to net cash flow from operating activities. In other words, the Indirect method adjusts net income for items that affected reported net income but didn't affected cash. To compute net cash flows from operating activities, noncash changes in the income statement are added back to net income, and net cash credits are deducted. Explanations for the two adjustments to net income in this example―namely, the accounts receivable and accounts payable―are as follows.
Increase in Accounts Receivable―Indirect Method:
When accounts receivable increase during the year, revenues on an accrual basis are higher than on a cash basis because goods sold on account are reported as revenues. In other words, operations for the period led to increased revenues, but not all of these revenues resulted in an increase in cash. Some of the increase in revenues resulted in an increase in accounts receivable. To convert net income to net cash flow from operating activities, the increase of $36,000 in accounts payable must be deducted from net income.
Increase in Accounts Payable―Indirect Method:
When accounts payable increase during the period, expenses on an accrual basis are higher than they are on a cash basis because expenses are incurred for which payment has not taken place. To convert net income to net cash flow from operating activities, the increase of $5,000 in accounts payable must be added back to net income.
As a result of the accounts receivable and accounts payable adjustments, net cash provided by operating activities is determined to be $3,000 for the year 2003. This calculation is shown as follows.
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Increase in accounts receivable
Increase in accounts payable
Net cash provided by operating activities   
$(36,000)
$ 5,000   $34,000


($31,000)
----------
$ 3,000
=======
Note that net cash provided by operating activities is the same whether the direct or indirect method is used.
Step 3: Determine Net Cash Flows from Investing and Financing Activities:
Once the net cash flows from operating activities is computed, the next step is to determine whether any other changes in balance sheet accounts caused an increase or decrease in cash.
For example, an examination of the remaining balance sheet accounts for Tax Consultants Inc. shows that both common and retained earnings have increased. The common stock increase of $60,000 resulted from the issuance of common stock for cash. The issuance of common stock is a receipt of cash from a financing activity and is reported as such in the statement of cash flows. The retained earnings increase of $20,000 is caused by two items:
1.   Net income of $34,000 increased retained earnings
2.   Dividend declared of $4,000 decreased retained earnings.
Net income has been converted into net cash flows from operating activities, as explained earlier. The additional data indicates that the dividend was paid. Thus, the dividend payment on common stock is reported as cash outflow, classified as financing activity.
We are now ready to prepare the statement of cash flows. The statement starts with the operating activities section. Either the direct or indirect method may be used to report net cash flow from operating activates.
The statement of cash flows under indirect method for Tax Consultation Inc. is as follows.
Tax Consultants Inc.
cash flow statement-Indirect Method
For the year ended December 31, 2003
Cash Flows From Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Increase in accounts receivable
Increase in accounts payable
Net cash provided by operating activities
Cash Flows From Financing Activities:
Issuance of common stock
Payment of cash dividend
Net cash provided by financing activities
Net increase in cash
Cash, January 1, 2003
Cash, December 31, 2003   
$(36,000)
$ 5,000
---------------

$60,000
$(14,000)
----------   $34,000


($31,000)
-------------
$ 3,000
$46,000
-----------
49,000
-0-
----------
$49,000
=======
As indicated, the $60,000 increase in common stock results in a cash inflow from a financing activity. The payment of $14,000 in cash dividends is classified as a use of cash from a financing activity. The $49,000 increase in cash reported in the statement of cash flows agrees with the increase of $49,000 shown as the change in the cash account in the comparative balance sheet.

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3. "the effect of price reduction is always to reduce the p/v ratio, to raise the B.E P and shorten the MOS." explain with suitable example."

The Profit Volume (PV) Ratio
is the ratio of Contribution over Sales. It measures the Profitability of the firm and is one of the important ratios for computing profitabilty. The Contribution is the extra amount of sales over variable cost. Contribution is also Fixed cost plus profit.

Profit = Sales - Variable Cost - Fixed Cost.
Thus Contribution is:
Profit + Fixed Cost = Sales - Variable Cost.

Therefore PV Ratio = (Contribution/Sales)X100. (This as a percentage of sales)
=============================
Problem 1:
A company produces a single article. About its product, the following cost data has been given:
Selling price per unit $ 40
Marginal cost per unit $ 24
Fixed cost per annum $ 1600
Calculate: (a) P/V ratio, (b) Break-even sales,
(c) Sales to earn a profit of $ 2000, (d) Profit at sales of $ 12000,
(e) If sales price is reduced by 10%, then a new break-even sales.
Solution: We know that Sales – Variable cost = Fixed cost + Profit
By multiplying & dividing left hand side by Sales
Or, Sales (Sales –Variable Cost)/Sales = Fixed cost + Profit
Or, Sales * P/V ratio = Contribution
(a) P/V ratio = Contribution / Sales * 100
= [(40-24)/40] * 100
= 16/40 * 100
= 40%
(b) Break-even Sales = Sales * P/V ratio= Fixed cost
Or, Sales * 40% = 1600
Or, Sales = 1600/40
Or, Sales = $ 4000 (or 200 units)
(c) Sales to earn a profit of $ 2000
Sales * P/V ratio = Fixed cost + Profit
Or, Sales * 40% = 1600 + 2000
Or, Sales = 1800/40%
Or, Sales = $ 4500 (or 112.5 units)
(d) Profit at sales of $ 12000
Sales * P/V ratio = Fixed cost + Profit
Or, 12000 * 40% = 1600 + Profit
Or, Profit = $ 3200
(e) New Break-even sales, if sales price is reduced by 10%
New Sales price = $40 - $4 = $36
Marginal cost = $24
Contribution = $36 - $24 = $12
P/V ratio = Contribution / Sales
= (12/36) *100 = 33.33%
B.E.S * P/V ratio = Fixed Cost (at B.E.P, contribution is equal to fixed cost)
Or, B.E.S = 1600/33.33%
Or, B.E.S = $ 4800



Problem 2: Break-even point
A company, which currently utilizing 80% capacity with a turnover of $ 1600000 at $ 50 per unit, manufactures a product. The cost data are as under:
Material cost $ 15 per unit, Labour cost $ 12.50 per unit.
Semi-variable cost (including variable cost of $ 7.50 per unit) - $ 360000
Fixed cost $ 180000 up to 80% level of output, beyond this an additional $ 40000 will be incurred.
Calculate: (a) Activity level at Break-even point;
(b) Number of units which need to be sold so that net income of 8% can be earned.
(c) Activity level needed for earning a profit of $ 190000; &
(d) If break-even point is to be brought down to 40% activity level, what will be the selling price per unit?
Solution:
(a) Activity level of break-even point
Sales at BEP * P/V ratio = Fixed Cost
Or, Sales at BEP= Fixed cost/ P/V ratio
Or, Activity level of break-even point = (Fixed cost/ P/V ratio) / Selling Price
= {$ 300000/ (15/50)} / 50
= 2 0000 units
= (20000 / 40000) * 100 = 50%
(b) Let us assume that for earning net income of 8% of sales, the number of units sold be x:
Or, $ 50x – 35x = $ 300000 + 8% of ($ 50x)
Or, $ 50x – 35x = $ 300000 + 4x

Or, x = 27273 units.
(c) Activity level needed to earn a profit of $ 190000:
Sales required to earn a profit of $ 190000 = (Fixed cost + Desired profit) / contribution per unit.
Required sales = $ (300000 + 40000 + 190000) / 15
= 35333 units
Thus, activity level needed to earn a profit of $ 190000 = (353330/40000) * 100 = 88.33%.
(d) Selling price per unit if break-even point is to be brought down to 40% (or 16000 units):
Let us assume that selling price = X
Activity level at BEP = 16000
16000 units = (Fixed cost / P/V ratio) / Selling price
16000 units = $300000 * X_ * 1
X-35 X
Or, 16000X -560000 = 300000
Or, X = (560000+300000) / 16000 = $ 53.75
Working Notes: $
(1) Selling price 50
Variable cost (15+12.50+7.50) 35
Contribution per unit 15
(2) Number of units sold at 80% capacity = $1600000/50 = 32000 units
Maximum capacity = 32000/80% = 40000 units
(3) Fixed cost element in semi-variable cost: $
Semi-variable cost 360000
Less: Variable cost 32000 units @ $ 7.50 240000
Fixed cost element 120000
(4) Total fixed cost of 80% capacity = $ 180000+ $ 120000 = $300000
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THIS  IS  THE  REAL /ACTUAL  PROBLEM
Equipment A has a cost of Rs.75,000 and net cash flow of Rs.20000 per year for six years. A substitute equipment B would cost Rs.50,000 and generate net cash flow of Rs.14,000 per year for six years. The required rate of return of both equipments is 11 per cent. Calculate the IRR and NPV for the equipments. Which equipment should be accepted and why
=========================================
(b) Equipment A has a cost of Rs. 75,000 and net cash flow of Rs. 20,000 per year for
six years. A substitute equipment B would cost Rs. 50,000 and generate net cash
flow of Rs. 14,000 per year for six years. The required rate of return of both
equipments is 11 per cent. Calculate the IRR and NPV for the equipments. Which
equipment should be accepted and why?
Calculation of Net Present Value (NPV) and Internal Rate of Return (IRR) for
Equipment A and Equipment B
Equipment A:
NPV = 20,000 PVAF6,0.11 – 75,000
= 20,000 4.231 – 75,000
= 84,620 – 75,000 = Rs. 9,620
------------------------------------------------
IRR = 20,000 PVAF6,r = 75,000
PVAF6,r = 75,000 / 20,000 = 3.75
From the present value of an annuity table, we find:
PVAF6,0.15 = 3.784
PVAF6,0.16 = 3.685
==============================

Therefore,

IRR =r = 0.15 +0.01 [  3.784- 3.75 ] /  [ 3.784 – 3.685 ]
= 0.15 + 0.0034
= 0.1534 or 15.34%.
============================
Equipment B:
NPV = 14,000 PVAF6,0.11 – 50,000
= 14,000 4.231 – 50,000
= 59,234 – 50,000 = Rs. 9,234

IRR = 14,000 PVAF6,r = 50,000

PVAF6,r = 50,000/14,000 = 3.571
From the present value of an annuity table, we find:
PVAF6,0.17 = 3.589
PVAF6,0.18 = 3.498



Therefore,
RR = r = 0.17 + .0.01  [ 3.589-3.571 ] / [3.589 -3.498]

IRR r 0.17 0.01 3.589 3.571
= 0.17 + 0.002 = 0.172 or 17.20%.
Recommendation: Equipment A has a higher NPV but lower IRR as compared to
Equipment B. Therefore, Equipment A should be preferred since the wealth of the shareholders will be maximized.  

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