After conducting a survey that cost Rs.2,00,000, X Ltd., decided to undertake a project for placing a new p the market.

The companys cut-off rate is 12 per cent. It was estimated that the project would cost Rs.40,0 plant and machinery in addition to working capital of Rs.10,00,000. The scrap value of plant and machin end of 5 years was estimated at Rs.5,00,000. After providing for depreciation on straight-line basis, profit 1 were estimated as follows: 1 2 3 Year 3,00,000 8,00,000 13,00,000 PAT (Rs.) Ascertain the net present value of the projects with 12 cost of capital. Solution :

Working Note 1 Calculation of Cash outflows Cost of Equipment Add: Survey Cost Additional Working Capital Calculation of NPV PAT (Rs.)

Rs

40,00,000 2,00,000 10,00,000 52,00,000 DF 12%

Year

CFAT (Rs.)

1 2 3 4 5

3,00,000 8,00,000 13,00,000 5,00,000 4,00,000

10,40,000 15,40,000 20,40,000 12,40,000 11,40,000

0.893 0.797 0.712 0.636 0.567 PV of cash inflows

Add: PV of working capital 10,00,000 0.567 Add: PV of Scrap value 5,00,000 0.567

Total PV of Cash inflows Less: PV of cash outflows

NPV

Working notes 2: Depreciation: Original cost + Survey cost Scrap value Life of machinery = (40,00,000 + 2,00,000 5,00,000)/5 = Rs. 7,40,000 Depreciation should be added to PAT of every year to get CFAT

ake a project for placing a new product on at the project would cost Rs.40,00,000 in scrap value of plant and machinery at the tion on straight-line basis, profits after tax 4 5 5,00,000 4,00,000

Present Values (Rs.) 9,28,720 12,27,38 0 14,52,48 0 7,88,640 6,46,380 50,43,60 0 5,67,000 2,83,500

58,94,10 0 52,00,00 0 6,94,000

e Life of machinery

A firm has two investment opportunities, each costing Rs.1,00,000 and 2 each having an expected profit as shown below: 1 2 3 4 Year 50,000 40,000 30,000 10,000 Project X (Rs.) 20,000 40,000 50,000 60,000 Project Y (Rs.) After giving due consideration to the risk criteria in each project the management has decided that project A should be evaluated at a 10 per cent cost of capital and project B, a risky project with a 15 per cent cost of capital. Compare the NPV and suggest the course of action for the management if a) Both the projects are independent, b) Both are mutually exclusive Solution : Calculation of NPV Year CFAT (Rs.) DF % PVs (Rs.) Project Project 10 15 Project Project B B A A 1 50,000 20,000 0.909 0.78 45,450 17,400 2 40,000 40,000 0.826 0.756 33,040 30,240 3 30,000 50,000 0.751 0.657 22,530 32,850 4 10,000 60,000 0.683 0.572 6,830 34,320 Present Value of cash inflows 1,07,850 1,14,810 1,00,000 1,00,000 Less: Cash outflows Net Present Values (NPV) 7,850 14,810 a) If both the projects are independent, accept both the projects, as NPV b) If both the projects are mutually exclusive, accept project B as its NPV is higher than that of Project A.

X Ltd., is considering the purchase of a new machine, which will carry out some operations at present performed by labour. Two alternative models A and B are available for the purpose. From the following information prepare a profitability 3 statement for submission to management and calculate PBP. Machine A Machine B Rs. Rs. Estimated life (Years) 5 6 Cost of Machine (Rs.) 80,000 1, 50,000 Estimated additional cost (Rs.) Indirect material (p.a) 2,000 3,000 Maintenance (p.m) 500 750 Supervision (per quarter) 3,000 4,500 Estimated savings in scrap (p.a.) 8,000 12,000 Estimated savings in direct wages a. workers not required 10 15 b. wages per worker p.a. 7,200 7,200 Depreciation is calculated under straight-line method. Taxation may be taken at 50 per cent of net profit (net savings). Solution : Profitability Statement Particulars Estimated savings p.a. Scrap Direct Wages: A - 10x7,200 ; B 15 x 7,200 Total savings Additional costs Indirect material Maintenance: A 500 x 12 ; B 750 x 12 Supervision: A 3,000 x 4 ; B 4500 x 4 Total cost Net savings (EBDT) (Savings cost) Less: Depreciation EBT

Machine A (Rs.) Machine B (Rs.) 8,000 72,000 80,000 2,000 6,000 12,000 20,000 60,000 16,000 44,000 12,000 1,08,000 1, 20,000 3,000 9,000 18,000 30,000 90,000 25,000 65,000

Less: Taxes at 50 per cent EAT Add: Depreciation Annual cash inflow (CFAT)

22,000 22,000 16,000 38,000

32,500 32,500 25,000 57,500

Machine X =Rs.80,000 38,000 = 2.1 Years Machine Y =Rs.1,50,000 57,500 = 2.61 Years Depreciation: Machine X=Rs.80,000/6=Rs. 16,000; Machine Y=Rs.1,50,000/5=Rs. 25,000

The following two projects A and B require an investment of Rs. 2, 00,000 each. The income 4 after taxes for these projects is as follows: Year Project Project A (in B (in Rs.) Rs.) 1 80,000 20,000 2 80,000 40,000 3 40,000 40,000 4 20,000 40,000 5 ------- 60,000 6 ----- 60,000 Using the following criteria, determine which of the project is preferable: (i) 8 years pay back; (ii) Average Rate of Return iii) Present value approach if the companys cost of capital is 10 per cent Solution: Note 1: Depreciation = Initial cost Salvage value Life period Project A: (Rs.2,00,000 0) 4 = Rs.50,000; Project B: (Rs.2,00,000 0) 6 = Rs.33,333 Calculation of Cash inflows Year Project A Project B EAT Cash Cumulat EAT Cash Cumulat inflow ive inflow ive (Rs.) (Rs.) CFAT (Rs.) (Rs.) CFAT (Rs.) (Rs.) 1 80,000 1,30,000 1,30,000 20,000 53,333 53,333 2 80,000 1,30,000 2,60,000 40,000 73,333 1,26,666 3 40,000 90,000 3,50,000 40,000 73,333 1,99,999 4 20,000 70,000 4,20,000 40,000 73,333 2,73,332 5 --------------------60,000 93,333 3,66,665 6 --------------------60,000 93,333 4,59,998 i) Initial investment = 2, 00,000 PBP: Project A: 1+ (70,0001,30,000) = 1.76 Years; Project B = 3 years Decision: Based on 8 years pay back both the projects should be selected Project A should be selected since their PBP is less than the 8 years pay back period which is to considered as standard pay back period. But Project A should be selected because its pay back period is less than the Project B. ii) Computation of Average Rate of Return = (Annual Avg. IAT Average investment) 100

Annual Average Income (AAI)= Total EAT No. of years Project A: 2,20,000 4 = Rs.55,000; Average Investment = 2,00,000 2 = Rs.1,00,000 Average rate of return = (55,000 / 1,00,000)100 = 55 per cent Project B: AAI = 2,60,000 6 = Rs. 36,667 Average investment = 2,00,000 2 = Rs. 1,00,000 Average rate of return = (36,667 / 1,00,000)100 = 36.67 per cent Decision: Project A should be selected since its ARR is greater than the Project B. c) Computation of Net Present Value (NPV) Year CFAT (in Rs.) DF PVs (in Rs.) Project Project 10 % Project Project A B A B 1 1,30,000 53,333 0.909 1,18,170 48,480 2 1,30,000 73,333 0.826 1,07,380 60,573 3 90,000 73,333 0.751 67,590 55,073 4 70,000 73,333 0.683 48,181 50,086 5 -------93,333 0.621 -------- 57,960 6 -------93,333 0.564 ------ 52,640 Present Value of cash 3,41,321 3,24,812 inflows 2,00,000 2,00,000 Less: Cash outflows Net Present Values 1,41,321 1,24,812 (NPV) Decision: Based on the NPV both the Projects A and B eligible to accept. However, Project A is preferable since its NPV is more than that of Project B.

00 each. The income

0 0) 6 = Rs.33,333

A company is considering an investment proposal to install a new machine. The project will cost Rs. 50,0 have life and no salvage value. Tax rate is 50 per cent, the company follows straight-line method of depre 5 net income before depreciation and tax is as follows: Year 1 2 3 NIBDT 10,000 11,000 14,000 (Rs.) Evaluate the project using: (a) PBP (b) ARR (c) NPV at 10 per cent and (d) PI at 10 per cent Solution: Calculation of CFAT (Rs.) Year EBDT EBT (Rs.) (Rs.) 1 2 3 4 5 10,000 11,000 14,000 15,000 25,000 (EBDT-Dep.) 1,000 4,000 5,000 15,000

EAT (Rs.) (EBT-Tax) 500 2,000 2,500 7,500

Note: Depreciation = (Original cost Salvage value) Life period = (Rs. 50,000 0) 5 = Rs. 10,000 (a) Calculation of Pay back period: Pay Back Period = 4+ (5,000 / 17,500) = 4.29 years b) Computation of ARR: (Annual Average Income After Tax Average Investment) 100 Annual Average Income = 12,5005 = Rs. 2,500 Average Investment = 50,0002 = Rs.25,000 ARR = (2,50025,000)100 = 10 per cent c) Computation of Net Present Value (NPV) Year CFAT DF 10 % (Rs.) 1 10,000 0.909 2 10,500 0.826

PVs (Rs.) 9,090 8,673

3 12,000 0.751 4 12,500 0.683 5 17,500 0.621 Present Value of cash inflows

9,012 8,538 10,868 46,181

50,000 Less: Cash outflows Net Present Value (-) 3,819 d) Computation of Profitability Index (PI): PV of cash inflows Initial

investment
= Rs. 46,181 50,000 = 0.92 paise PI indicates that for every one rupee of investment the project will generate only 0.92 paise, in other words the project will incur a loss of 0.08 paise for every one rupee of investment.

. The project will cost Rs. 50,000 and will s straight-line method of depreciation. The 4 15,000 5 25,000

CFAT Cumulat (Rs.) ive (EAT+D CFAT ep.) (Rs.) 10,000 10,000 10,500 20,500 12,000 32,500 12,500 45,000 17,500 62,500