Estimating the Project Cash Flows

1. Naveen Enterprises is considering a new investment project about which the following information is available. a) The total outlay on the project will be Rs.100 mn. This consists of Rs.60 mn. on plant and equipment and Rs.40 mn. on gross working capital. The entire outlay will be incurred at the beginning of the project. b) The project will be financed as follows: Equity capital: Rs.40 mn. Long-term debt (debentures): Rs.30 mn. Short-term bank borrowings: Rs.20 mn Trade credit : Rs.10 mn This means that Rs. 70 mn. of long-term funds (equity + long-term debt) will be applied towards plant and equipment (Rs.60 mn.) and net working capital (Rs.10 mn.) The interest rate on debentures will be 13.5 per cent and the interest rate on short-term borrowings will be 20 per cent. The life of the project is expected to be 5 years. At the end of 5 years, plant and equipment would fetch a salvage value of Rs. 20 mn. The liquidation value of working capital will be equal to Rs.40 mn., its book value. The project will increase the revenues of the firm by Rs.80 mn. per year. The increase in expenses on account of the project will be Rs.40 mn. per year. (This includes all items of expenses other than depreciation, interest on debentures, and taxes). The effective tax rate will be 50 per cent. Plant and equipment will be depreciated at the rate of 33 1/3 % per year as per the written down value method. So the depreciation charges will be: Rs. mn. First year 20.00 Second year 13.33 Third year 08.89 Fourth year 05.93 Fifth year 03.95

c)

d)

e)

2. XYZ Company is considering replacement of its existing machine by a new machine, which is expected to cost Rs.1,60,000/-. The new machine will have a life of 5 years and will yield annual cash revenues of Rs.2,50,000/and incur annual cash expenses of Rs.1,30,000/-. The estimated salvage value of the new machine is Rs.8,000/-. The existing machine has a book value of Rs.40,000/- and can be sold for Rs.20,000/- today. It is good for the next 5 years and is estimated to generate annual cash revenues of Rs.2,00,000/- and to involve annual cash expenses of Rs.1,40,000/-. If sold after 5 years, the salvage value of the existing machine can be

expected to be Rs.2,000/-. XYZ Company pays tax at 35 per cent, and can write off depreciation at 25 per cent on the written-down value of the asset. The companys opportunity cost of capital is 20 per cent. *****