Appraise a capital proposal using incremental cash flows, then compare the approved assumptions with actual costs and performance. Keep investment appraisal, financing and financial statement recognition separate. The worked examples are fictional. Cash flows are in ₹ lakh unless stated otherwise; figures use unrounded calculations.
Five ways to appraise a project
Ind AS governs recognition, measurement and impairment in financial statements. It does not prescribe these investment approval metrics. Use a consistent project perimeter, include opportunity costs and working capital, and make tax, inflation, timing and residual assumptions explicit.
| Metric | Calculation | When it helps | Limitations |
|---|---|---|---|
| Simple payback | First time cumulative undiscounted cash flows recover outlay. For constant annual inflows, divide outlay by annual inflow. | Initial liquidity screen. | Ignores the time value of money and later cash flows. |
| Accounting rate of return | Average annual accounting profit divided by the chosen average investment base. | Connects to reported profitability. | State the denominator; book depreciation and other accounting choices affect the result. |
| Net present value (NPV) | Discount all incremental cash flows, including the initial outlay, at a rate matched to their timing and risk. | Compares value on a common basis, including mutually exclusive projects. | Depends on the forecast, terminal assumptions and discount rate. |
| Internal rate of return (IRR) | Discount rate at which project NPV is zero. | Supplement to NPV for conventional cash-flow patterns. | Can rank projects differently from NPV or yield multiple rates or no meaningful rate. A reinvestment rate is not an input to the IRR equation. |
| Discounted payback | First time cumulative discounted cash flows recover the outlay. | Screen for timing and liquidity using the selected discount rate. | Ignores subsequent cash flows, including later outflows. |
Select a consistent discount rate
For unlevered project cash flows, a risk-matched weighted average cost of capital (WACC) can be appropriate. A simple debt-and-equity model weights the cost of equity and marginal debt cost after the usable interest tax shield. Do not deduct financing cash flows from the unlevered forecast as well. If modelling equity cash flows after financing, use an equity discount rate. Avoid charging for the same risk in both cash flows and the discount rate.
Illustration: 40% equity at 16%, 60% debt at 10.5%, with a fully usable tax shield at 25.168%, gives 6.40% plus 4.71%, or 11.11%. The business may use a 14% hurdle for a riskier project if the adjustment is supported. Regulatory or safety projects may require a different decision framework. A common input for cost of equity is the CAPM estimate of risk-free rate plus beta times an equity risk premium; the inputs depend on the project and valuation date.
Where used below, 25.168% is the illustrative effective rate from the AY 2026–27 section 115BAA regime: 22% tax, 10% surcharge on tax and 4% cess on tax plus surcharge. The model holds the selected tax inputs constant for comparison. Check the applicable legislation, eligibility, depreciation classification and the timing and usability of deductions for each actual tax year.
Seven worked examples
1. Robotic welding: replace manual stations
A manufacturer compares replacing 12 manual stations with two robot cells. Initial outlay is ₹240 lakh, life six years, net disposal proceeds ₹20 lakh at the end, and hurdle rate 12%. Assume annual labour savings of ₹108 lakh, scrap and rework savings of ₹32 lakh (defects fall from 4.2% to 0.4% on the assumed process), and incremental maintenance, power and technical staff costs of ₹14 lakh, ₹12 lakh and ₹18 lakh. Net annual operating benefit before tax is ₹96 lakh.
Assume ordinary plant eligible for 15% written-down-value (WDV) depreciation, full first-year eligibility, sufficient taxable profit, and a continuing tax block with positive WDV. Reduce the year-six depreciation base by ₹20 lakh when disposal occurs. The forecast ends at disposal and omits subsequent block tax effects. The example assumes no incremental working capital.
| Year | Incremental depreciation | Net cash flow | 12% discount factor | Present value | Cumulative PV |
|---|---|---|---|---|---|
| 0 | — | -240.00 | 1.0000 | -240.00 | -240.00 |
| 1 | 36.00 | 80.90 | 0.8929 | 72.23 | -167.77 |
| 2 | 30.60 | 79.54 | 0.7972 | 63.41 | -104.36 |
| 3 | 26.01 | 78.38 | 0.7118 | 55.79 | -48.57 |
| 4 | 22.11 | 77.40 | 0.6355 | 49.19 | 0.62 |
| 5 | 18.79 | 76.57 | 0.5674 | 43.45 | 44.07 |
| 6 | 12.97 | 95.10 | 0.5066 | 48.18 | 92.25 |
The year-six cash flow includes ₹20 lakh of proceeds. NPV is ₹92.25 lakh, IRR 24.55%, simple payback about 3.02 years and discounted payback about 3.99 years. The profitability index is 1.38. Payback fractions assume within-year interpolation; annual cash balances cross zero at the end of year four in this schedule.
2. MRI equipment: buy or lease
A hospital compares a ₹850 lakh purchase with a seven-year lease at ₹16.50 lakh per month, including maintenance and helium. For purchase, assume ₹8.50 lakh annual helium cost, ₹38 lakh annual maintenance in years 3–7 and ₹1.20 lakh of year-seven resale proceeds. Use an effective annual discount rate of 10.5%. The model assumes equal service, fully usable contemporaneous cash tax relief at 25.168%, deductible operating costs, a 15% WDV scenario for the purchase and a continuing positive tax block. The equipment’s actual depreciation rate and rent deductibility require separate verification.
- Purchase: present value of net operating costs is ₹117.63 lakh, the depreciation tax shield is ₹105.76 lakh and the discounted proceeds are ₹0.60 lakh. Adding the purchase outlay gives a net present cost of ₹861.27 lakh.
- Lease: gross rent is ₹198 lakh per year, with annual-equivalent tax relief of ₹49.83 lakh under the assumptions. Discount the 84 month-end post-tax payments at the monthly equivalent of 10.5% annually. Net present cost is ₹743.15 lakh, ₹118.12 lakh less than purchase. The break-even gross monthly rent is ₹19.12 lakh; a negotiated ₹15.20 lakh would reduce lease cost to ₹684.60 lakh.
- Financing check: a ₹680 lakh seven-year loan at 9.5%, with equal annual year-end instalments, would require about ₹137.38 lakh annually and ₹170 lakh of upfront equity. These amounts are excluded from the unlevered comparison. Check financing and covenant effects separately.
Review maintenance scope and the stated year-four upgrade option. A lessee that applies Ind AS 116 generally recognises a right-of-use asset and lease liability for the lease component unless an exemption applies. Tax deductions and the treatment of service components require separate analysis. Leasing does not automatically keep liabilities off the balance sheet.
3. Captive solar: value the energy savings
A plant uses 3,50,000 kWh of grid electricity per month at ₹8.40 per kWh. A 2 MW solar project costs ₹920 lakh and generates 30,00,000 kWh in year one. Assume full self-consumption and an avoided tariff rising 3% annually, generation declining 0.7% annually, ₹18 lakh annual maintenance, 25 years of operation, no residual value and an 11% hurdle. The annual gross savings start at ₹252 lakh, leaving ₹234 lakh before tax and depreciation relief.
Assume all ₹920 lakh qualifies as a solar power generating system in the 40% WDV block under the legacy Rule 5 schedule, with full first-year allowance and immediate use of deductions. Do not apply this rate to the entire turnkey package without classifying the actual components; short first-year use can also affect the allowance. At 25.168%, the first two years’ depreciation tax shield is ₹148.19 lakh; cash flows are ₹267.73 lakh and ₹234.98 lakh respectively. The model gives NPV of ₹1,030.91 lakh, IRR of 24.81%, simple payback of 3.96 years and discounted payback of 5.64 years.
At an evenly averaged 2,50,000 kWh of monthly solar generation, remaining grid purchases would average 1,00,000 kWh and the variable grid charge would fall from ₹29.40 lakh to ₹8.40 lakh at the starting tariff. Actual savings depend on hourly generation and load, fixed charges, curtailment and grid settlement.
4. Warehouse automation: check savings and capacity
A parcel warehouse evaluating a high-speed sorter invests ₹550 lakh. Replacing 120 of its assumed 180 temporary positions saves ₹288 lakh a year, avoided penalties save ₹42 lakh, and power and maintenance cost ₹58 lakh. Annual net cash savings are ₹272 lakh. On five equal year-end cash flows, with no additional tax, working capital or disposal cash flows, the simple payback is 2.02 years, discounted payback 2.51 years, IRR 40.38% and NPV at 13% is ₹406.69 lakh.
Test the assumed 12,000 parcels per hour and 99.98% accuracy at the relevant parcel mix, including peaks, jams and downtime. Treat the ₹42 lakh benefit as an assumption until claims and service-level records support it.
5. Textile expansion: reconcile delay, CWIP and revised economics
A project expected to commission in nine months instead commissions in 23, a 14-month delay. At ₹30 lakh a month the illustrative foregone operating contribution is ₹420 lakh. It is a separate diagnostic; do not deduct it again when the model already delays operating cash flows.
| Capitalisation input | Budget | Actual | Variance |
|---|---|---|---|
| Civil works and machinery | 1,280 | 1,440 | 160 |
| Eligible borrowing costs | 68 | 188 | 120 |
| Other eligible project costs | 152 | 157 | 5 |
| Total | 1,500 | 1,785 | 285 (19.0%) |
For an illustrative unlevered DCF, model the non-interest spend as time-zero equivalents of ₹1,432 lakh and ₹1,597 lakh. Assume six annual operating cash flows of ₹475 lakh in the plan and ₹425 lakh in the updated forecast, each starting one year after commissioning. At 11.5%, NPV moves from positive ₹393.59 lakh to negative ₹158.38 lakh; IRR falls from 18.77% to 9.25%. Accounting capitalisation of interest is separate from the cash-flow appraisal, and delays may require suspending capitalisation under Ind AS 23.
6. Cloud ERP: separate inventory release from recurring savings
Assume a ₹320 lakh implementation spend, a permanent ₹336 lakh inventory release in year one (12% of ₹2,800 lakh), and annual operating benefits of ₹28 lakh from process improvements plus a supportable ₹18 lakh of reduced losses or compliance costs. Assume these ₹46 lakh net annual benefits continue for six years. Do not count the estimated ₹37 lakh interest saving as an additional benefit when the unlevered model already values the cash release.
At 12%, the six-year permanent-release scenario has NPV of ₹169.12 lakh, IRR of 45.94% and a first simple payback crossing around 0.84 years. If benefits last only five years and the inventory must be rebuilt for ₹336 lakh at the end of year five, the model instead gives NPV of negative ₹44.84 lakh. In that scenario early payback does not capture the later cash outflow. Establish the evidence for each benefit; no software guarantees penalty avoidance.
A cloud project outlay for appraisal purposes is not necessarily an accounting asset. For hosted software, assess whether the customer controls identifiable software or code; otherwise evaluate the service and the period in which it is received. Assess any prepayment separately.
7. Bottling line: compare approved and actual performance
Eighteen months after commissioning a ₹600 lakh line, management compares the first year with plan. Planned 240 bottles per minute fell to 175, 27.08% below plan. Output fell from 4.5 million to 3.1 million crates, 31.11% below plan. Keep the bottles-per-minute rate separate from annual crate volumes; pack sizes, downtime and yields connect the two.
At ₹14.50 contribution per planned crate, the planned gross contribution was ₹652.50 lakh before the assumed ₹467.50 lakh of other net operating cash costs, leaving ₹185 lakh. Actual maintenance and spares were ₹38 lakh versus ₹14 lakh budgeted, a ₹24 lakh variance. Actual net operating cash flow of ₹92 lakh was 50.27% below plan. Reconcile the remainder to output, mix, margins and other cash items instead of attributing it all to maintenance.
Investigate the assumed tooling and bottleneck issue and check remedies against the contract. If the supplier’s work restores 225 bottles per minute, that is 93.75% of the original rating. Verify the sustained production and cash impact separately.
Set approval and post-completion checks
- Before appraisal, record the strategic objective, operational baseline, alternative choices and estimated spending.
- At approval, retain the dated forecast, the hurdle rate, the cash-flow assumptions, financing and covenant implications, and sensitivities. Align approval authority with the organisation’s actual delegation.
- During delivery, track spend, commitments, scope changes, the expected date available for use, and accounting evidence. Escalate delays while decisions can still change.
- After commissioning, review the planned and actual cash flows, utilisation and maintenance at dates set by policy, for example at months 6 and 18. Agree corrective actions and track them.
Frequently asked questions
1. How do inflation and discount rates interact?
Use nominal cash flows with a nominal rate or real cash flows with a real rate. The equivalent real rate is (1 + nominal rate) ÷ (1 + inflation rate) − 1. Consider specific price changes even when modelling in real terms.
2. Should past costs affect a replacement decision?
Exclude irrevocably incurred costs from forward-looking choices. Include the current opportunity cost of keeping an asset, cash disposal proceeds, incremental taxes and avoidable costs. This is a decision rule, separate from Ind AS 16 recognition.
3. When does depreciation begin?
Under Ind AS 16, eligible costs include amounts directly attributable to bringing the asset to the location and condition necessary for its intended operation. Assess advances and pre-operating spending separately; not all are CWIP. Depreciation begins when the asset is available for use, even if output is below capacity. Book depreciation and income-tax depreciation follow different rules.
4. When are borrowing costs capitalised?
Under Ind AS 23, capitalise directly attributable borrowing costs for a qualifying asset. The standard defines this by the substantial period needed to get ready, without a universal 12-month threshold. Start when expenditure, borrowing costs and necessary activities are all present. Suspend during extended interruptions in active development and cease when substantially all preparation activities are complete, taking separately usable parts into account.
5. Can IRR misrank mutually exclusive projects?
Yes. Consider one-year cash flows: ₹10 lakh invested for ₹18 lakh produces 80% IRR; ₹1,000 lakh invested for ₹1,250 lakh produces 25%. At a 12% hurdle their NPVs are ₹6.07 lakh and ₹116.07 lakh respectively. Compare NPV at appropriate risk-adjusted rates and consider capital constraints and unequal lives where relevant.
6. What should a post-completion review capture?
Match actual invoices and ready-for-use dates to the approved project, then compare throughput, cost, working capital and realised cash flows with the dated case. Retain the reasons for variances and the owner and deadline of each action.
Sources
- ICAI compendium: Ind AS 16, recognition and depreciation
- ICAI compendium: Ind AS 23, borrowing costs
- ICAI compendium: Ind AS 116, lessee accounting
- ICAI compendium: Ind AS 36, impairment
- Income Tax Department: domestic-company rates for AY 2026–27
- Income-tax Rules, 1962: New Appendix I under Rule 5
- Income-tax Act, 1961: section 43(6), written down value
- IFRS Interpretations Committee: cloud configuration and customisation costs (comparative guidance)