Chapter 10: Determining Cash Flows for Investment Analysis

Problem 1
Assumption: (1) It is assumed that the given annual cash inflows are after-tax. (2) ARR is
calculated as average cash profit divided by original investment. Alternatively, average
investment (original investment/2) can be used for calculation.

Required rate 10%

Tax rate 35%
Projects A B C D E
Outlay -500,000 -120,000 -92,000 -5,750 -40,000
Annual inflows 125,000 12,000 15,000 2,000 6,000
Life 8 15 20 5 10
PVAF @10% 5.3349 7.6061 8.5136 3.7908 6.1446
PV of NCF 666,865.8 91,273.0 127,703.5 7,581.6 36,867.4
NPV 166,865.8 -28,727.0 35,703.5 1,831.6 -3,132.6
IRR 18.6% 5.6% 15.4% 21.8% 8.1%
PB (years) 4 10 6.13 2.88 6.67
ARR 25.0% 10.0% 16.3% 34.8% 15.0%

Rank
Project NPV IRR PB ARR
A 1 2 2 2
B 5 5 5 5
C 2 3 3 3
D 3 1 1 1
E 4 4 4 4

Problem 2

Cost of capital 10%

Tax rate 35%
Cost of project X 20,000
Life of project X 5
Straight line depreciati 4,000
Cost of project Y 15,000
Life of project Y 5
Straight line depreciat 3,000

PROJECT X
Year 0 1 2 3 4 5
BT cash flows -20,000 4,200 4,800 7,000 8,000 2,000
AT cash flows (T =
35%) 2,730 3,120 4,550 5,200 1,300
Add: DTS (Dep. × T =
4,000 × .35 ) 1,400 1,400 1,400 1,400 1,400
NCF -20,000 4,130 4,520 5,950 6,600 2,700
PVF 1.000 0.909 0.826 0.751 0.683 0.621
PV (Rs) -20,000 3,755 3,736 4,470 4,508 1,676
NPV (Rs) -1,855
PI 0.91
IRR 6.29%
Accumulated cash
flows -20000 -15870 -11350 -5400 1200 3900
Payback (years) 4

PROJECT Y
Year 0 1 2 3 4 5
BT cash flows -15,000 4,200 4,500 4,000 5,000 1,000
AT cash flows (T =
35%) 2,730 2,925 2,600 3,250 650
Add: DTS (Dep. × T = 1,050 1,050 1,050 1,050 1,050
3,000 × .35 )
NCF -15,000 3,780 3,975 3,650 4,300 1,700
PVF 1.000 0.909 0.826 0.751 0.683 0.621
PV (Rs) -15,000 3,436 3,285 2,742 2,937 1,056
NPV (Rs) -1,544
PI 0.90
IRR 5.59%
Cumulative cash -15000 -11220 -7245 -3595 705 2405
flows
Payback (years) 4
Both projects have negative NPV and IRR less than the cost of capital. They should be rejected.

Problem 3

Required rate of 10%

return
Tax rate 35%
Outlay M: 100,000
Life (years) 5
S L depreciation: 20,000
100,000/5
Salvage value (SV) 0
Outlay N: 140,000
Life (years) 5
SV 20,000
S L depreciation: 28,000
140,000/5

PROJECT M
Year 0 1 2 3 4 5
Book value (BV) 100,000 80,000 60,000 40,000 20,000 0
SL depreciation 20,000 20,000 20,000 20,000 20,000
Earnings before 25,000 25,000 25,000 25,000 25,000
depreciation & tax
Less: dep. 20,000 20,000 20,000 20,000 20,000
Earnings before tax 5,000 5,000 5,000 5,000 5,000
Tax at 35% 1750 1750 1750 1750 1750
Earnings after tax 3,250 3,250 3,250 3,250 3,250
(EAT)
Plus: dep. 20,000 20,000 20,000 20,000 20,000
Plus: SV 0
NCF -100,000 23,250 23,250 23,250 23,250 23,250
PVF 1.000 0.909 0.826 0.751 0.683 0.621
PV (Rs) -100,000 21,136 19,215 17,468 15,880 14,436
NPV (Rs) -11,864
IRR 5.24%
Cumulative NCF -100,000 -76,750 -53,500 -30,250 -7,000 16,250
Payback (years) 4 1/2

Project N
Year 0 1 2 3 4 5
Book value 140,000 112,000 84,000 56,000 28,000 0
S L depreciation 28,000 28,000 28,000 28,000 28,000
Earnings before 40,000 40,000 40,000 40,000 40,000
depreciation & taxes
Less: dep. 28,000 28,000 28,000 28,000 28,000
Earnings before taxes 12,000 12,000 12,000 12,000 12,000
Tax 4,200 4,200 4,200 4,200 4,200
Earnings after tax 7,800 7,800 7,800 7,800 7,800
Plus: dep. 28,000 28,000 28,000 28,000 28,000
After-tax salvage 13,000
NCF -140,000 35,800 35,800 35,800 35,800 48,800
PVF 1.000 0.909 0.826 0.751 0.683 0.621
PV (Rs) -140,000 32,545 29,587 26,897 24,452 30,301
NPV (Rs) 3,782
IRR 11.0%
Cum. NCF -140,000 -104,200 -68,400 -32,600 3,200 52,000
Payback 4
* After-tax salvage: 20,000 - .35(20,000 – 0) = Rs 13,000.

Problem 4

Year 0 1 2 3 IRR NPV, 12%

O -50,000 25,270 25,270 25,270 24% 10,694.3
P -25,000 5,000 5,000 25,570 15% 1,650.5
Q -28,000 12,670 12,670 12,670 17% 2,431.2
(P - Q) 3,000 -7,670 -7,670 12,900 -780.7
Project O has the highest NPV; hence it should be preferred over other projects. Between
projects P and Q, Q is better with higher NPV. The incremental cash flow analysis also
shows that P losses NPV when compared with Q.

Problem 5

Year 0 1 2 3 NPV, 10% IRR

A -6,000 8,000 2,000 2,000 4,428.2 65.6%
B -8,000 12,000 4,000 6,214.9 78.1%
(A - B) -6,000 16,000 -10,000 -2,000 -1,221.6
Both absolute and incremental analyses reveal that B is a better project than A.

Problem 6

Year 0 1 2 3 4 NPV, 10% IRR

Cash flow 7,000 7,000 7,000 7,000 -25,000 6,666.0 -4.5%

Problem 7
Required rate of 10%
return
Tax rate 40%
Purchase price 40,000
Installation 8,000
Total cost 48,000
Plus: WC 10,000
Less: SV, old 20,000 no tax assumed
Initial outlay 38,000
SV, new (4 yrs) 14,000
SV, old (4 yrs) 4,000
Differential SV after 4 10,000 no tax assumed
years
BV, old 16,000
Life (years), new 4
Life (years), old 4
SL dep., new 12,000
SL dep., old 4,000
Differential dep. 8,000
Diff. DTS 3,200
(depreciation tax
shield): 8,000 × 0.40
Year 0 1 2 3 4
Initial outlay -38,000
BT cash flows 16,000 16,000 16,000 16,000
AT cash flows: 9,600 9,600 9,600 9,600
16,000 × (1-.4)
DTS 3,200 3,200 3,200 3,200
Differential SV 10,000
NCF -38,000 12,800 12,800 12,800 22,800
NPV 9,404.41
IRR 20%

Problem 8

Investment 300,000
Required rate 15%
Tax rate 30%
Investment period 13
Building 140,000
Merchandise 100,000
Working capital 60,000
Total investment 300,000

Annual receipts 390,000

Less: Costs 300,000
Less: SL dep. on 10,769
build. (140,000/13)
Pre-tax savings 79,231
Tax @ 30% 23,769
Post-tax savings 55,462
Add: Dep. 10,769
Less: Loss of salary (no tax on salary 36,000
assumed)
NCF (annuity) 30,231
Post-tax SV: 50,000 × (1 – 0.3) 35,000
Release of WC and merchandise 160,000
Year-end CF 195,000
PVAF, 15%, 13 5.5831
PVF, 15%, 13 0.1625
PV of annuity 168,781
PV of year-end CF 31,688
NPV -99,531
Problem 9
(Rs.'000)
BV, old 64,000
Life, old (years) 6
Cost, new 80,000
Life, new (years) 6
SV, new 0
Savings, new 16,000
WDV dep. rate 25%
Tax rate 30%
Required rate 10%

Situation I
SV, old (now) 0
SV, (after 6 years) 0
BV, old 64,000
Dep. base, new 80,000
Diff. dep. base (80,000-64,000) 16,000
Year 0 1 2 3 4 5
Depreciated value 16,000 12,000 9,000 6,750 5,063 3,797
WDV dep. 4,000 3,000 2,250 1,688 1,266
Investment -80,000
Savings 16,000 16,000 16,000 16,000 16,000
Less: depreciation* 4,000 3,000 2,250 1,688 1,266
Taxable savings 12,000 13,000 13,750 14,313 14,734
Less: Tax @ 30% 3,600 3,900 4,125 4,294 4,420
Post-tax savings 8,400 9,100 9,625 10,019 10,314
Add: depreciation* 4,000 3,000 2,250 1,688 1,266
After-tax SV (old) lost
NCF -80,000 12,400 12,100 11,875 11,706 11,580
PVF 1.000 0.909 0.826 0.751 0.683 0.621
PV -80,000 11,273 10,000 8,922 7,996 7,190
NPV -27,655
* New machine has zero salvage value. Its book value of Rs 2,848 at the end of 6th year will be treated as loss and
will save taxes. This amount has been added to the sixth year's depreciation.

Situation II
SV, old (now) 16000
BV, old 64,000
After-tax SV, old: 16,000 - .35(16,000-64,000) 30,400 Assumption given in the problem
SV, old (after 6 years) 0
Cost of new 80,000
Less: After-tax SV, old 30,400
Net cost of new 49,600
Diff. dep. base (80,000-64,000) 16,000
Year 0 1 2 3 4 5
Depreciated value 16,000 12,000 9,000 6,750 5,063 3,797
WDV depreciation 4,000 3,000 2,250 1,688 1,266
Investment -49,600
Savings 16,000 16,000 16,000 16,000 16,000
Less: depreciation* 4,000 3,000 2,250 1,688 1,266
Taxable savings 12,000 13,000 13,750 14,313 14,734
Less: Tax 3,600 3,900 4,125 4,294 4,420
Post-tax savings 8,400 9,100 9,625 10,019 10,314
Add: depreciation* 4,000 3,000 2,250 1,688 1,266
After-tax SV (old) lost
NCF -49,600 12,400 12,100 11,875 11,706 11,580
PVF 1.000 0.909 0.826 0.751 0.683 0.621
PV -49,600 11,273 10,000 8,922 7,996 7,190
NPV 2,745
* New machine has zero salvage value. Its book value of Rs 2,848 at the end of 6th year will be treated as loss and
will save taxes. This amount has been added to the sixth year's depreciation.

Situation III
SV, old (now) 16000
BV, old 64,000
After-tax SV, old: 16,000 - .35(16,000-64,000) 30,400 Assumption given in the problem
SV, (after 6 years) 2,000
BV, old (after six years): 64,000 × (1-0.25)6 11391
After-tax SV, old: 2,000 - .35(2,000-11,391) 4,817
Cost of new 80,000
Less: After-tax SV, old 30,400
Net cost of new 49,600
Diff. dep. base (80,000-64,000) 16,000
Year 0 1 2 3 4 5
Depreciated value 16,000 12,000 9,000 6,750 5,063 3,797
WDV depreciation 4,000 3,000 2,250 1,688 1,266
Investment -47,200
Savings 16,000 16,000 16,000 16,000 16,000
Less: depreciation* 4,000 3,000 2,250 1,688 1,266
Taxable savings 12,000 13,000 13,750 14,313 14,734
Less: Tax 3,600 3,900 4,125 4,294 4,420
Post-tax savings 8,400 9,100 9,625 10,019 10,314
Add: depreciation* 4,000 3,000 2,250 1,688 1,266
After-tax SV (old) lost
NCF -47,200 12,400 12,100 11,875 11,706 11,580
PVF 1.000 0.909 0.826 0.751 0.683 0.621
PV -47,200 11,273 10,000 8,922 7,996 7,190
NPV 2,426
* New machine has zero salvage value. Its book value of Rs 2,848 at the end of 6th year will be treated as loss and
will save taxes. This amount has been added to the sixth year's depreciation.

Problem 10
(Rs.'00)
Old Machine:
BV 0
Current MV 20,000
After-tax SV: 20,000-.35(20,000- 13,000
0)
SV after 8 years 0
Remaining life 8
(years)

New Machines (Vs Old): (Rs.'00)

I II
Cost 102,500 175,000
SV after 8 years 12,500 25,000
BV after 8 years 10,262 17,520
After-tax SV: SV-.35(SV-BV) 11,717 22,382
Life (years) 8 8
Dep. rate (WDV) 0.25 0.25
Tax rate 0.3 0.3
Cost of capital 0.11 0.11
Increase in sales 12,500 12,500
Cost savings 12,500 30,000
Gross savings 25,000 42,500
After-tax savings (T = 30%) 17,500 29,750
Diff. dep. base: Cost, new – BV, ol 102,500 175,000
New investment: cost – After-tax SV, old (Rs 1 89,500 162,000

New machine I (Vs Old):

Years 0 1 2 3 4 5 6
Diff. dep. Base 102,500 76,875 57,656 43,242 32,432 24,324 18,243
Depreciation 25,625 19,219 14,414 10,811 8,108 6,081
Dep. Tax shield 8,969 6,727 5,045 3,784 2,838 2,128
After-tax savings 17,500 17,500 17,500 17,500 17,500 17,500
SV
NCF -89,500 26,469 24,227 22,545 21,284 20,338 19,628
PVF 1.000 0.901 0.812 0.731 0.659 0.593 0.535
PV (Rs) -89,500 23,846 19,663 16,485 14,020 12,069 10,494
NPV (Rs) 29,472
IRR 19.94%

New machine II (Vs Old) :

Years 0 1 2 3 4 5 6
Diff. dep. Base 175,000 131,250 98,438 73,828 55,371 41,528 31,146
Depreciation 43,750 32,813 24,609 18,457 13,843 10,382
Dep. Tax shield 15,313 11,484 8,613 6,460 4,845 3,634
After-tax savings 29,750 29,750 29,750 29,750 29,750 29,750
SV
NCF -162,000 45,063 41,234 38,363 36,210 34,595 33,384
PVF 1.000 0.901 0.812 0.731 0.659 0.593 0.535
PV (Rs) -162,000 40,597 33,467 28,051 23,853 20,530 17,848
NPV (Rs) 41,496
IRR 17.98%
The company should go for the new machine costing Rs 175,000 since it has higher NPV. NPV is consistent with shareho

Problem 11

The block of assets method of depreciation in India requires adjustment of salvage value in
the depreciable base. Thus, if an asset has no salvage value, it can be depreciated for ever
(infinity) if the firm keeps the positive balance in the block of assets. If it has a salvage
value, the balance of the block will be reduced for the amount of salvage value less
depreciation tax shield lost on this amount.
Old Machine: (Rs.'000)
Depreciated BV 0
Exchange value 40,000
Current MV 30,000
SV after 10 years 6,000
Remaining life 10
(years)
New Machine:
Cost 360,000
SV after 10 years. 40,000
Life (years) 10
WDV dep. rate 25%
Required rate 12%
Tax rate 50%
Tax rate is inferred from given
data.

Old New Differenc

e
Profit before tax 373,000 449,000 76,000
Add: dep. 2,000 36,000 34,000
Add: allocated
overhead 120,000 130,000 10,000
PBDT 495,000 615,000 120,000
Tax @ 50% 247,500 307,500 60,000
PBDAT 247,500 307,500 60,000

Years 0 1 2 3 4 5 6
New block 320,000 240,000 180,000 135,000 101,250 75,938 56,953
Dep. 80,000 60,000 45,000 33,750 25,313 18,984
DTS 40,000 30,000 22,500 16,875 12,656 9,492
PBDAT 60,000 60,000 60,000 60,000 60,000 60,000
CFO 100,000 90,000 82,500 76,875 72,656 69,492
Investment -320,000
SV
Lost DTS on SV
NCF -320,000 100,000 90,000 82,500 76,875 72,656 69,492
PVF 1.000 0.893 0.797 0.712 0.636 0.567 0.507
PV (Rs) -320,000 89,286 71,747 58,722 48,855 41,227 35,207
NPV (Rs) 135,649
IRR 22.45%
* Last year DTS includes DTS (for infinity) on the remaining book value: BV × (d × T)/(k + d) = 18.020 × (0.25 × 0.50)/(0.12
Note: Exchange value is higher than the current market value. Hence, the relevant salvage value of the old machine is Rs

Problem 12

Old Machine: (Rs.'000)

Original cost (Rs) 129,000
Original life (yrs) 12
Remaining life (yrs) 7
Depreciation rate 25%
BV after 5 years 30,612 (1-0.25)^5*129,000
BV after 12 years 4,086 (1-0.25)^12*129,000
Current MV 40,000
New Machine:
Cost 175,000
Installation 25,000
Total cost 200,000
Working capital 25,000
Gross outlay 225,000
Life (years) 7
Depreciation rate 0.25
SV (Rs) 18,000
BV after 7 years 23,360 (1-0.25)^7*175,000

Cost of capital 12%

Tax rate 30%

Increase in sales 70,000

After-tax revenue: 70,000×(1-.35) 45,500
Gross outlay 225,000
Less: SV, old 40,000
Net outlay 185,000
Diff. Dep. Base: 200,000 - 40,000 160,000

Year 0 1 2 3 4 5 6
Diff. dep. base 160,000 120,000 90,000 67,500 50,625 37,969 28,477
Differential dep. 40,000 30,000 22,500 16,875 12,656 9,492
DTS *
12,000 9,000 6,750 5,063 3,797 2,848
After-tax revenue 45,500 45,500 45,500 45,500 45,500 45,500
SV
DTS lost on SV**
WC released
Net outlay -185,000
NCF -185,000 57,500 54,500 52,250 50,563 49,297 48,348
PVF 1.000 0.893 0.797 0.712 0.636 0.567 0.507
PV (Rs) -185,000 51,339 43,447 37,191 32,133 27,972 24,494
NPV 72,884
IRR 23.2%
* Last year DTS includes DTS on remaining book value: 21,357 × (.25× .35)/(.12 + .25) = Rs 5,051.
** DTS lost on SV: 18,000 × (.25 × .35)/(.25 + .12) = -4,257.

Problem 13
(Rs.'000)
Purchase price 175,000
Life (years) 5
SV (Rs) 21,000
Maintenance cost 3,500
SL dep. 35,000
Tax rate 35%
Cost of capital 10%

0 1 2 3 4 5
Outlay -175,000
Tax saved on depreciation 12,250 12,250 12,250 12,250 12,250
After-tax SV 13,650
NCF -175,000 12,250 12,250 12,250 12,250 25,900
PVF 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209
PV (Rs) -175,000 11,136 10,124 9,204 8,367 16,082
NPV (Rs) -120,087
* Tax payable on book profit. After-tax SV = 21,000 – 0.50(21,000 – 0)

Hiring option: 0 1 2 3 4 5
Hire charges (Rs) 0 -42,000 -42,000 -42,000 -42,000 -42,000
After-tax hire charges (Rs) 0 -27,300 -27,300 -27,300 -27,300 -27,300
PVF 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209
PV (Rs) 0 -24,818 -22,562 -20,511 -18,646 -16,951
NPV (Rs) -103,488
Maintenance cost being common in both options is ignored in calculating cash flows.
Hiring option is cheaper.

Problem 14

Cost of capital 0.18

Tax rate 0.3
Dep. Rate 0.25

Project P 0 1 2 3 4 5 6

Investment 250,000 187,500 140,625 105,469 79,102 59,326 44,495

Depreciation 62,500 46,875 35,156 26,367 19,775 14,832
Additional investment 45,000 33,750
Depreciation 11,250
Total depreciation 62,500 46,875 35,156 26,367 19,775 26,082

Before-tax cash flows 90,000 90,000 90,000 90,000 90,000 90,000

After-tax cash flows 63,000 63,000 63,000 63,000 63,000 63,000
DTS *
18,750 14,063 10,547 7,910 5,933 7,824
Investment -250,000 -45,000
Working capital -50,000
Salvage value
Lost DTS on SV**
WC released
NCF -300,000 81,750 77,063 73,547 70,910 23,933 70,824
PVF 1.000 0.847 0.718 0.609 0.516 0.437 0.370
PV -300,000 69,280 55,345 44,763 36,575 10,461 26,236
NPV 24,778
IRR 20.28%
* Includes DTS on the remaining book value: (14,078 + 10,679) × (.25 × .50)/(.25 + .18) = Rs 7,197.
# Lost DTS on VS: Rs 30,000 × (.25 × .50)/(.25 + .18) = Rs 8,721.

Problem 15

Cost 100,000
Life (years) 5
Straight line dep. (Rs) 20,000
Savage value 0
Savings 40,000
Tax rate 0.5
Cost of capital 0.18

Year 0 1 2 3 4 5
Investment -100,000
After-tax savings 20,000 20,000 20,000 20,000 20,000
Tax saved on dep. 10,000 10,000 10,000 10,000 10,000
Salvage value 0
NCF -100,000 30,000 30,000 30,000 30,000 30,000
PVF 1.0000 0.8475 0.7182 0.6086 0.5158 0.4371
PV (Rs) -100,000 25,424 21,546 18,259 15,474 13,113
NPV (Rs) -6,185 -6,185
IRR 15.20%
Here we ignore the effect of specific financing. The cost of capital, which assumes a target capital
structure, is used as the discount rate.

Problem 16

Project cost (Rs) 50,000

Cost savings (Rs) 30,000
Period (years) 5
Tax rate 35%
Required rate 0.12
Straight line dep. (Rs) 10,000
Salvage value 0

Year 0 1 2 3 4 5
Investment (Rs) -50,000
After-tax cost savings (Rs) 19,500 19,500 19,500 19,500 19,500
Tax saved on dep. (Rs) 3,500 3,500 3,500 3,500 3,500
Salvage value (Rs) 0
NCF (Rs) -50,000 23,000 23,000 23,000 23,000 23,000
PVF 1.0000 0.8929 0.7972 0.7118 0.6355 0.5674
PV (Rs) -50,000 20,536 18,335 16,371 14,617 13,051
NPV (Rs) 32,910 32,910
IRR 36.18%
Here we ignore the effect of specific financing. The cost of capital, which assumes a target capital
structure, is used as the discount rate.

Problem 17
(Rs 000)
Old New New - Old
Capacity (units) 3 4 1
Selling price 200 180 -20
Revenue 600 720 120
Cost of production:
Materials 40 38 2
Labour 60 40 20
Variable overheads 30 15 15
Fixed overheads 2 -2
Per unit production cost 130 95 35
Total production cost 390 380 10
Profit 210 340 110
Original cost of machine (Rs) 300 500
Current book value 200
Exchange (salvage) value 100
After-tax salvage value: 100,000-.5(100,000 – 200,000) 150
Tax saved on book loss 50
Net outlay (Rs): 500,000 - 150,000 350
Salvage value after 10 years 50
After-tax salvage value: 50,000 - .5(50,000 – 0) 25
Remaining life (years) 10 10
Straight line dep. 20 50 30
Working capital 25
Tax rate 0.5
Required rate of return 0.15
Year 0 1 2 3 4 5 6
Cost of machine -200 -200
Working capital -25
Tax saved on SV 50
Revenue 120 120 120 120 120 120
Cost savings 10 10 10 10 10 10
Increase in profits 130 130 130 130 130 130
After-tax profits 65 65 65 65 65 65
Dep. tax shield 15 15 15 15 15 15
After-tax SV
Release of WC
NCF -175 -120 80 80 80 80 80
PVF 1.000 0.870 0.756 0.658 0.572 0.497 0.432
PV (Rs) -175 -104 60 53 46 40 35
NPV (Rs) 65 65
IRR 20.2%

Problem 18

Initial cost (Rs) 200,000

Life (years) 5
Cash inflow (Rs) 70,000
Cost of capital (real) 10.00%
Inflation 5.00%
Nominal cost of capital: [(1.10)(1.05) - 1] 15.50%
Assumptions: (1) It is assumed that both cash flows and the cost of capital are in real terms.
(2) Nominal cash flows are calculated as follows: Real cash flows × (1 + inflation rate)n.

Year 0 1 2 3 4 5 Dis. rate

Cash flows (real) -200,000 70,000 70,000 70,000 70,000 70,000 10.00%
Nominal cash flows -200,000 73,500 77,175 81,034 85,085 89,340 15.50%
It may be noticed that NPV is the same in both situations. The real cash flows are discounted at the nominal cost of
capital, and real cash flows at the real cost of capital.

Problem 19

Discount rate 20%

Tax rate 35%
General inflation rate 10%

Year 0 1 2 3 4 5
Cost -500,000
Volume 20% 10,000 12,000 14,400 17,280 20,736
Price 10% 20 22 24.2 26.62 29.28
Cost per unit 15% 10 11.50 13.23 15.21 17.49
Revenue 200,000 264,000 348,480 459,994 607,192
Total cost 100,000 138,000 190,440 262,807 362,674
Profit 100,000 126,000 158,040 197,186 244,518
Less: dep. 100,000 100,000 100,000 100,000 100,000
PBT 0 26,000 58,040 97,186 144,518
Tax 0 9100 20314 34015 50581
PAT 0 16,900 37,726 63,171 93,936
Add: dep. 100,000 100,000 100,000 100,000 100,000
NCF -500,000 100,000 116,900 137,726 163,171 193,936
PVF at 20% 1.000 0.833 0.694 0.579 0.482 0.402
PV at 20% -500,000 83,333 81,181 79,703 78,690 77,939
NPV -99,155 -99155
IRR 11.6%
Price increases at general inflation rate while cost increases by a higher rate of inflation. It is assumed
that the cost of capital is market determined; hence, it is in nominal terms.

Problem 20

Cash outlay 6,000,000

Life of project (years) 7
Sales growth: 2-7 years 10%
Increase in expenses 10%
Initial working capital 500,000
WC to sales 25%
WDV dep. rate 25%
Tax rate 35%
Opportunity cost of capital 21%
Salvage value: 0.20 × 6,000,000 × (1.10)7 2,338,461

Nominal Cash Flows

Year 0 1 2 3 4 5 6
Cash outlay -6,000,000
Sales 1,200,000 2,000,000 2,200,000 2,420,000 2,662,000 2,928,200
Op. expenses 600,000 660,000 726,000 798,600 878,460 966,306
PBDIT 600,000 1,340,000 1,474,000 1,621,400 1,783,540 1,961,894
Depreciation 1,500,000 1,125,000 843,750 632,813 474,609 355,957
Profit/loss -900,000 215,000 630,250 988,588 1,308,931 1,605,937
Loss carried forward -900,000 -685,000 -54,750 0 0
Unrecovered loss -900,000 -685,000 -54,750 0 0 0
Taxable profit 0 0 0 933,838 1,308,931 1,605,937
Tax 0 0 0 326,843 458,126 562,078
PAT 0 215,000 630,250 661,744 850,805 1,043,859
Add: depreciation 1,500,000 1,125,000 843,750 632,813 474,609 355,957
Funds from operation 1,500,000 1,340,000 1,474,000 1,294,557 1,325,414 1,399,816
Initial working capital -500,000
Change in WC -300,000 -200,000 -50,000 -55,000 -60,500 -66,550
Release of WC
Salvage value
NCF -6,500,000 1,200,000 1,140,000 1,424,000 1,239,557 1,264,914 1,333,266
PVF, 21% 1.000 0.826 0.683 0.564 0.467 0.386 0.319
PV -6,500,000 991,736 778,635 803,811 578,262 487,679 424,820
NPV -1,100,836 -1,100,836
IRR 15.7%
Theoretically, the answer should not change if the analysis is made in terms of real terms. The real cash flows
would be discounted at the real cost of capital. However, since flows like deprecation tax shields are always in
nominal terms, it is difficult to use real cash flow analysis.
 6
2,848
949

16,000
3,797
12,203
3,661
8,542
3,797
0
12,339
0.564
6,965

l be treated as loss and

he problem

6
2,848
949

16,000
3,797
12,203
3,661
 8,542
3,797
0
12,339
0.564
6,965

l be treated as loss and

he problem

Depriciation schedule 16000

6
2,848
949

16,000
3,797
12,203
3,661
8,542
3,797
-4,817
7,522
0.564
4,246

l be treated as loss and

 7 8
13,682 10,262
4,561 3,421
1,596 1,197
17,500 17,500
11,717
19,096 30,414
0.482 0.434
9,198 13,197

7 8
23,360 17,520
7,787 5,840
2,725 2,044
29,750 29,750
22,382
32,475 54,176
0.482 0.434
15,642 23,508

NPV is consistent with shareholdr

 7 8 9 10
42,715 32,036 24,027 18,020
14,238 10,679 8,009 6,007
7,119 5,339 4,005 9,091
60,000 60,000 60,000 60,000
67,119 65,339 64,005 69,091

40,000
-13,514
67,119 65,339 64,005 95,578
0.452 0.404 0.361 0.322
30,361 26,389 23,081 30,774

= 18.020 × (0.25 × 0.50)/(0.12 + 0.25) = Rs .6,088

value of the old machine is Rs 40,000.
 7
21,357
7,119
6,465
45,500
18,000
-3,649
25,000

91,316
0.452
41,307

5,051.
 (Rs.'000)
7 8 9 10

33,371 25,028 18,771 14,078

11,124 8,343 6,257 4,693
25,313 18,984 14,238 10,679
8,438 6,328 4,746 3,560
19,561 14,671 11,003 8,252

90,000 90,000 90,000 90,000

63,000 63,000 63,000 63,000
5,868 4,401 3,301 6,794

30,000
-5233
50,000
68,868 67,401 66,301 144,561
0.314 0.266 0.225 0.191
21,619 17,931 14,948 27,621
 (Rs ‘000)
7 8 9 10

120 120 120 120

10 10 10 10
130 130 130 130
65 65 65 65
15 15 15 15
25
25
80 80 80 130
0.376 0.327 0.284 0.247
30 26 23 32

NPV
65,355
65,355
d at the nominal cost of
 7

3,221,020
1,062,937
2,158,083
266,968
1,891,116
0
0
1,891,116
661,890
1,229,225
266,968
1,496,193

-73,205
1,305,255
2,338,461
5,066,703
0.263
1,334,221

he real cash flows

elds are always in
Case 10.1: Hind Petrochemicals Company

(Rs mn.)
Cost of refinery 1,550 Depriciation schedule
Cost of machinery 5,950 7,500 5,625 4,219 3,164 2,373
Total capital investment 7,500 1,875 1,406 1,055 791 593
Working capital 300
Total cash outlay 7,800
dep rate 0.25
Discount rate 15%

Cash flows (Rs mn.)

0 1 2 3 4 5
Sales 5,730 5,930 5,870 3,790 4,500
Less: Wages and salaries 1,450 1,500 1,850 1,030 1,210
Selling and distribution costs 760 770 1,080 530 650
Materials and consumables 180 270 290 200 230
Depreciation (WDV) 1,875 1,406 1,055 791 593
Corporate office costs 100 100 100 100 100
Survey costs 15 - - - -
Total expenses 4,380 4,046 4,375 2,651 2,783
Profit (loss) before tax 1,350 1,884 1,495 1,139 1,717
Less: tax @ 35% 473 659 523 399 601
Profit after tax 878 1,224 972 740 1,116
Plus: depreciation 1,875 1,406 1,055 791 593
CFO 2,753 2,631 2,027 1,531 1,709
Cash outlay -7,800
Working capital released 300
Salvage value (3800) 3,800 2,020
Book value 1,780 505.05
Lost DTS on (SV -BV) -505
Net cash flows -7,800 2,753 2,631 2,027 1,531 5,304
NPV at 15% 1,428
IRR 22%

Cumulative casf flows -7,800 -5,048 -2,417 -390 1,141 6,445

Payback (years) 3.25
Case 10.2: Pure Drinks Company
Inflation considered
Number of sachets (mill 9
(Rs) Inflation
Price 65.0 4%
Variable costs:
Material 6.5 3%
Labour 3.5 5%
Overhead 5.0 5%
Fixed costs (Rs million) 0.0
Working capital ratio 30%
Tax rate 30%
Real discount rate 8.65%
General inflation rate 4%
Nominal discount rate 13%
Tax rate 30%
Cost of processing facili 2,100
Life 7
SL depreciation 300
Salvage value 1000
Current building opportu 1000 Cost today
Building opportunity cos 2000 Cost after 7 years
PV of building cost afte 850 Least of two

0 1 2 3 4 5 6
Revenue 585.00 608.40 632.74 658.05 684.37 711.74
Variable costs
Material 58.50 60.26 62.06 63.92 65.84 67.82
Labour 31.50 33.08 34.73 36.47 38.29 40.20
Overhead 45.00 47.25 49.61 52.09 54.70 57.43
Total 135.0 140.6 146.4 152.5 158.8 165.5
Fixed costs 0.00 0.00 0.00 0.00 0.00 0.00
Total cost 135.00 140.58 146.40 152.48 158.83 165.45
EBDIT 450.00 467.82 486.33 505.56 525.54 546.29
Depreciation 300.00 300.00 300.00 300.00 300.00 300.00
EBIT 150.00 167.82 186.33 205.56 225.54 246.29
Less: Tax 45.00 50.35 55.90 61.67 67.66 73.89
Post-tax earnings 105.00 117.47 130.43 143.89 157.88 172.40
Plus: depreciation 300.00 300.00 300.00 300.00 300.00 300.00
Cash flow from operations 405.00 417.47 430.43 443.89 457.88 472.40
Change in working capit -175.50 -7.02 -7.30 -7.59 -7.90 -8.21 -8.54
Free cash flows -175.50 397.98 410.17 422.84 436.00 449.66 463.86
Cost of processing facili -2,100
Cost of building 850
Salvage value
Less: Tax on (SV - BV)
Net cash flows -1425.17 397.98 410.17 422.84 436.00 449.66 463.86
NPV 52.91
Note: (1) Rs 5 million survey cost is sunk cost. Hence, it is ignored. (2) The corporate office fixed costs are irrelevant
for the project.
Rs million
7
740.21

69.85
42.21
60.30
172.4
0.00
172.37
567.84
300.00
267.84
80.35
187.49
300.00
487.49
222.06
709.55

1000
-30
1679.55