AMSOM – Corporate Finance: FAC413M

TYBBA – ADVANCED CAPITAL BUDGETING

1. Dodd Ltd is assessing a business investment opportunity, Project X, the estimated cash
flows for which are as follows: Rs ’000
Investment (Cash outflow on 1 January, 20 X 2) 250
Net annual cash flow inflow (arising on the last day of the year)
20 X 2 160
20 X 3 160
20 X 4 100
Cash inflow from residual value 31 December, 20 X 4 50

 All of the above figures are expressed at 1 January, 20X2 prices. Inflation is expected
to operate at 5% p.a. throughout the project’s life.
 The firm’s ‘real’ cost of finance is estimated at 10% p.a.
 Corporate tax is charged on profits at the rate of 20%, payable during the year in which
the profit is earned (assume that the taxable profit equals the net operating cash
flows).The assets, which will be bought in 20X2 and disposed of in 20X4, is of a type
that does not give rise to any tax relief on its cost nor a tax charge on its disposal.
Calculate (using ‘money’ cash flows), the net present value of Project.

2. Symphosis Ltd, engaged in software development is facing problem in evaluating the new
Proposal as there are frequent changes in expectation due to inflation. It has following
information; (Rs. In lakhs)
Year 1 2 3 4 5
Real Cash Inflow 10 12 15 8 5
The Projects cost of capital in Real terms is 10% and in Nominal Terms is 18.8%. Should
Co. go for new proposal which requires initial cost of Rs. 25 lakhs on software
development, if it considers inflation before making any investment decision?

3. Zumba Enterprise Ltd has Rs. 11,00,000 for investment purpose. From the following
available data make your selection assuming Projects are
I. Divisible & II. Indivisible
Projects Outflow Desirability Factor
1 4,00,000 1.23
2 2,00,000 0.94
3 3,50,000 1.21
4 4,00,000 1.19
5 3,00,000 1.22
6 4,00,000 1.06

AU/TYBBA/16-17/Sem – V/CF Compiled by Prof. Pervin Gandhi

4. A firm is unable or unprepared to invest more than £ 5,00,000 in the current year, but has
the following projects available to is £ £
Project Initial Investment NPV
A 1,00,000 15,000
B 1,50,000 29,000
C 1,40,000 31,000
D 2,10,000 22,000
E 1,80,000 36,000
Select which projects should be undertaken and in which order, if
a) Projects are Indivisible. b). Projects are Divisible

5. A company is considering installing a new machine in factory. The cost of machine is Rs.
50,000. Useful life is 5 years and salvage value is 9,000. Tax rate is 50%. The company
adopts straight line method of depreciation & same is allowed for tax purposes. The cash
flow before depreciation & tax from two mutually exclusive projects are as follows.
Year 1 2 3 4 5
Project – A (M/c – I) 10,000 10,692 12,769 13,462 20,385
Project – B (M/c – II) 15,000 13,600 10,000 9,400 8,750
Compute: Pay-back Period, Discounted Pay-back Method, ARR, NPV, PI& IRR. (r=10%)

6. A 5 year project involving software development. You believe that the technological
uncertainty associated with this industry leads to higher discount rates in future as under:
Year 0 1 2 3 4 5
Discount Rate 14% 15% 16% 18% 20%
Investment Cash Flow -12,000 4,000 5,000 7,000 6,000 5,000
Calculate the NPV of the Project.

7. Following are the data on a capital protect being evaluated by the management of X Ltd.:
Particulars Project - M
Annual Cost Saving Rs. 40,000 Discount 15% 14% 13% 12%
Factor
Useful life 4 years 1 Year 0.869 0.877 0.885 0.893
I.R.R. 1.064 2 year 0.756 0.769 0.783 0.797
Profitability Index (PI) 15% 3 year 0.658 0.675 0.693 0.712
NPV ? 4year 0.572 0.592 0.613 0.636
Cost of Capital ? 2.855 2.913 2.974 3.038
Cost of Project ?
Pay back ?
Salvage Value 0

8. X Ltd. an existing profit-making company, is planning to introduce a new product with

a projected life of 8 years. Initial equipment cost will be Rs. 120 lakhs and additional
equipment costing Rs. 10 lakhs will be needed at the beginning of third year. At the
end of the 8 years, the original equipment will have resale value equivalent to the cost
of removal, but the additional equipment would be sold for Rs. 1 lakhs. Working

AU/TYBBA/16-17/Sem – V/CF Compiled by Prof. Pervin Gandhi

 Capital of Rs. 15 lakhs will be needed. The 100% capacity of the plant is of 4,0 0,000
units per annum, but the production and sales-volume expected are as under:
Year Capacity in percentage
1 20
2 30
3-5 75
6-8 100
A sale price of Rs. 100 per unit with a profit-volume ratio of 60% is likely to be
obtained. Fixed Operating Cash Cost are likely to be Rs. 16 lakhs per annum. In
addition to this the advertisement expenditure will have to be incurred as under:
Year 1 2 3-5 6-8
Expenditure in Rs. lakhs each year 30 15 10 4

9. Santosh& Co. is considering setting up a new unit. The following data has been compiled
by the company for the purpose of determining the acceptability of the proposal for setting
up the new unit.
a) Land
1. To be paid at the time of purchase (t = 0) Rs. 2 Iakhs
2. 1st, 2nd & 3rd installments at the end of next Rs. 1 lakh each
3 following years. installment
b) Factory Building (Total Rs. 20 lakhs)
i. Initial payment on signing of contract Rs. 2 lakhs
ii. At the end of year 2 Rs. 10 lakhs
iii. Balance at the end of year 3 ` Rs. 8 lakhs
c) Plant, Machinery and Equipment
i. To be paid at the beginning of — Year 4 Rs. 15 lakhs
Year 5 Rs. 5 lakhs
d) Extra a margin for working capital
(at the end of year 5) Rs. 4 lakhs
e) Operations will begin in the 6th year &will continue for 10 years upto year 15
Assume revenue and costs at the end of each year.
f) Buildings, Plant, Machinery & Equipment will be depreciated on straight line method
(permissible for tax purposes also) over the 10 years starting from year 6, as under
g) Buildings are expected to be sold for Rs. 6 lakhs and land for Rs. 8 lakhs at the end.
h) Plant, Machinery & Equipment will be salvage value of Rs. 2 lakhs.
i) Cost of Capital is 12%.
j) Other operating data:
Annual Sales Rs. 30 lakhs & Variable costs of operation — Rs. 12 lakhs.
Fixed Costs (excluding depreciation) — Rs. 8 lakhs; and Tax Rate — 50%.
Advise whether the company should accept the project or reject it on the basis of NPV of
the project.
P. V. Factors at 12% for Re. 1
Year 1 2 3 4 5 6 7 8 9 10
P.V.Factor 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322
The company is subject to 50% tax and taking 12% as appropriate after tax Cost of
Capital, should the project be accepted?

AU/TYBBA/16-17/Sem – V/CF Compiled by Prof. Pervin Gandhi

10. Fill in the blanks.

Project Annual Cash Initial Cost of

Case IRR NPV PI
life Inflows Investment Capital
A 10 Rs. 1,00,000 (?) (?) 0.20 (?) 1.1089
Rs.
B 13 (?) 0.16 (?) Rs. 60,000 (?)
3,00,000
Rs.
C (?) Rs. 80,000 0.12 (?) (?) 1.25
3,61,600

11. Television Ltd. has a proposal for manufacturing car televisions The project would involve
cost of plant of Rs 550 lakh, installation cost of Rs 50 lakh and working capital of Rs.150
lakh. The annual capacity of the plant is to manufacture 20,000 sets.’ The price per set
would he Rs. 12,000. The variable cost ratio is expected to be 65%. The fixed post per
annum would be Rs. 300 lakh (without including depreciation). The company would have
to incur promotion expenditure of Rs.25 lakh in the fist year. Written-down depreciation
rate for tax purposes is 25%. Working capital requirement is estimated to be 25% of sales.
The company expects that the plant’s capacity utilization Over its economic life of 7 years
will be as follows:

Year 1 2 3 4 5 6 7
Capacity utilization (%) 25 40 50 75 100 100 100

The terminal value of the project is expected to be 20% of its original cost. Calculate the
project’s NPV assuming a target required rate of 14% and corporate tax rate of 52%.

12. ABC Company purchased a machine three years ago at a cost of Rs. 10,000. The machine
had a life of 8 years at the time of its purchase. It is being depreciated at 15% on declining
balance. The company is thinking of replacing it with a new machine costing Rs. 20,000
with an expected 5 year life. The profit before depreciation is estimated to increase by
Rs. 4,445 a year. Assume that the old and new machines will be now depreciated at 25%
on declining balance for tax purpose. The salvage value of the new machine is anticipated
as Rs, 500. The market value of the old machine today is Rs. 11,500. It is estimated to have
zero salvage value after 5 year. The income tax rate may be assumed as 55%. The
company’s after-tax cost of capital is 12%. Should the new machine be bought?

13. A Ltd is considering new automatic blender. The new blender would last for 10yrs and
would be depreciated to zero over same 10 years. The old blender has a book value of Rs.
20,000 but could be sold for Rs. 30,000(original cost = Rs. 40,000).
The new blender would cost Rs. 1,00,000. It would reduce labour expenses by Rs. 12,000
a year. The company is subject to 50% tax rate on regular income & 30% on capital gains.
Cost of capital is 8%. It is the only asset in the block. Advise whether above project is
attractive or not.

AU/TYBBA/16-17/Sem – V/CF Compiled by Prof. Pervin Gandhi

14. Malabar Corporation is determining the cash flow for a project involving replacement of
an old machine by a new machine. The old machine bought a few years ago has a book
value of Rs.1,200,000 and it can be sold to realise a post tax salvage value of Rs.800,000.
It has a remaining life of four years after which its net salvage value is expected to be
Rs.500,000. It is being depreciated annually at a rate of 20 percent the WDV method. The
working capital associated with this machine is Rs.700,000. The new machine costs
Rs.5,000,000. It is expected to fetch a net salvage value of Rs.2,500,000 after four years.
The depreciation rate applicable to it is 20 percent under the WDV method. The new
machine is expected to bring a saving of Rs.800,000 annually in manufacturing costs (other
than depreciation).The incremental working capital associated with the new machine is
Rs.200,000. The tax rate applicable to the firm is 34 percent. (a) Estimate the cash flow
associated with the replacement project. (b) What is the NPV of the replacement project if
the cost of capital is 15 percent?

15. Metcalf Engineering is considering a proposal to replace one of its hammers. The following
information is available.
(1) The existing hammer was bought 2 years ago for Rs. 10 lakh. It has been depreciated
at the rate of 331/3 % per annum. It can be presently sold at its book value. It has a
remaining life of 5 years after which, on disposal, if would fetch a value equal to its
then book value.
(2) The new hammer costs Rs.16 lakhs. It will be subject to a depreciation rate of 331/3%.
After 5 years it is expected to fetch a value equal to its .book value. The replacement
of the old hammer would increase revenues by Rs. 2 lakhs per’ year and reduce
operating cost (excluding depreciation) by Rs. 1.5 lakh per year.
Compute the incremental post-tax cash flows associated with the replacement
proposal, assuming a tax rate of 50%.

16. Sangeeta Enterprises is determining the cash flow for a project involving replacement of
an old machine by a new machine. The old machine bought a few years ago has a book
value of Rs.2,800,000 and it can be sold to realise a post tax salvage value of Rs.2,200,000.
It has a remaining life of five years after which its net salvage value is expected to be
Rs.900,000. It is being depreciated annually at a rate of 30 percent the WDV method. The
working capital associated with this machine is Rs.1.000,000. The new machine costs
Rs.8,000,000. It is expected to fetch a net salvage value of Rs.3,500,000 after five years.
The depreciation rate applicable to it is 25 percent under the WDV method. The new
machine is expected to bring a saving of Rs.1,000,000 annually in manufacturing costs
(other than depreciation).The incremental working capital associated with the new machine
is Rs.600,000. The tax rate applicable to the firm is 33 percent. (a) Estimate the cash flow
associated with the replacement project. (b) What is the NPV of the replacement project if
the cost of capital is 14 percent?

17. Veromoda Ltd is planning to undertake new project for manufacturing new Tiles. The new
machine for the same will cost Rs. 1500000 and will last for 5 years. The old machine,
which was purchased 4 years back for Rs. 900000, will be of no use if new machine is
purchased. If sold today, it will fetch Rs. 240000. Method of depreciation followed by

AU/TYBBA/16-17/Sem – V/CF Compiled by Prof. Pervin Gandhi

 company is SLM and total life of old machine is 9 years. Tax on profit/loss on sale of asset
is @ 20%. Cost of capital is 12%. Compute net cash outflow if replacement decision is
undertaken.

18. BS- Electronics is considering a proposal to replace one of its machines. In this connection,
the following information is available :
The existing machine was bought 3 years ago for Rs. 10 Iakhs. It was depreciated at 25%
on reducing balance basis. It has remaining life of 5 years, but its maintenance cost is
expected to increases by Rs. 50,000 p.a. from the 6th year of its installation. Its present
realizable value is Rs. 6 lakhs.
The new machine costs Rs. 15 lakhs and is subject to the same rate of depreciation. On sale
after 5 years, it is expected to net Rs. 9 lakhs. With the new machine, operating costs
(excluding depreciation) are expected to decrease by Rs. 1 lakh p.a. In addition, the speed
of the new machine would increase productivity on account of which net revenues would
increase by Rs. 1.5 lakhs p.a.
The tax rate applicable is 50% and the cost of capital 10%. The Present Value Factors at
10% rate of discount for year 1 to 5 are respectively 0.909 0.826, 0.751 0.686 and 0.620.
Is the proposal financially viable? Please advise the firm on the basis of Net Present Value
of the proposal.

19. Singham & company is considering the purchase of a new machine. The old machine is in
good working condition & will last for six years. However the new machine will operate
efficiently. It is expected that materials, direct labour& other expenses for the operations
will be saved to the extent of Rs. 16,000 p.a.
The new machine will cost Rs. 80,000 and will last for six years and expected to fetch Rs.
12,000 at the end. The old machine has a book value of Rs. 64,000. The after tax minimum
required rate of return expected by the company is 10%. Assume 25% written down
depreciation and a 35% tax rate on income. Assume that profit or loss from sale of assets
is taxed at 30%. What action should the company take in following cases:
a) Salvage value of Old Machine today is 16,000 and if retained for six years, its
salvage value will be nil.
b) Salvage value of Old Machine today is nil.

20. A machine purchased six years back for Rs - 1,50,000 has been depreciated to a book value
of Rs. 90,000. It originally had a projected life of fifteen years and zero salvage value. A
new machine will cost Rs. 2,50,000 and result in a reduced operating cost of Rs. 30,000
per year for the next nine years. The older machine could be sold for Rs. 50,000. The
machine also will be depreciated on a Straight line method on nine-year life with salvage
value of Rs. 25,000. The company’s tax rate is 50% and cost of capital is 10%.
Determine whether the old machine should be replaced?
Given Present Value of Re. 1 at 10% on 9th year = 0.424, and present value at an annuity
of Re. 1 at 10% for 8 years = 5.335.

21. A plastic manufacturer has under consideration the proposal of production of high quality
plastic glasses. The necessary new equipment to manufacture the same will cost Rs. 1 lakh
and would last for 5 years. The expected salvage value is Rs. 10,000. Depreciation is @

AU/TYBBA/16-17/Sem – V/CF Compiled by Prof. Pervin Gandhi

 25% and it is the only asset in the block. Existing Machine, purchased two years back, has
the book value Rs. 28,125 today. It can be sold today for Rs. 12,000 and will fetch nothing
at the end of 5 years. The glass can be sold for Rs. 4 each. Regardless of level of production
manufacturer will incure a cash cost of Rs. 25,000 each year if the project is undertaken.
O/h cost allocated to this new pipeline is Rs. 5,000. Variable costs are estimated at Rs. 2
per glass. Manufacturer estimates to sell 75000 glasses per year. Tax rate is 35%. Should
the proposed equipment be purchased? Cost of capital 20% and additional working capital
requirement is Rs. 50,000.

22. Livelong Ltd. has the continuing need for a cutting machine to perform a particular function
vital to the firm’s activities. There are two machines on the market, the Alpha and the Beta.
Investigations show that the data relating to costs and life expectancy of each machine are
as follows:
Alpha Beta
Acquisition cost £ 50,000 £ 90,000
Residual value at the end of the machine’s useful life £ 5,000 £ 7,000
Annual running cost £ 10,000 £ 8,000
Useful life 4 years 7 years
The two machines are identical in terms of capacity and quality of work. The relevant cost
of finance is 10% p.a. Produce workings that should which machine is the most
economical. By how much, and in which direction would the acquisition cost of an Alpha
need to alter in order for the two machines to be equally economical?
Ignore taxation and inflation.

23. ABC Chemicals Ltd. is considering two mutually exclusive proposals for its expansion
programme. Annual revenues and out-of-pocket operating cost of these two proposals are
as follows:
Proposal - I Proposal - lI
Purchase price of equipment Rs. 8,00,000 Rs. 19,40,000
Salvage value at the end of useful life Rs. 1,00,000 Rs. 1,80,000
Useful life (years) 7 11
Annual incremental revenues Rs. 5,00.000 Rs. 7,50,000
Annual incremental cash operating cost Rs. 2,40,000 Rs. 3,60,000
The firm’s tax rate is 35%, and its required rate of return is 12%. The equipment will be
depreciated by straight line method and the same is allowed for tax purposes. Which of the
two proposals should be chosen?

24. Shyam Ltd is presently operating with a machine (WDV of Rs. 40,000; Salvage Value
today Rs. 20000) and it can be used for next 5 years to generate net annual earnings of Rs.
60,000 (before depreciation & tax).The salvage value after 5 years is expected to be Rs.
2,000 only. The machine could be replaced by a new machine costing Rs. 1,60,000(Life 5
years; Salvage Value Rs. 8,000). The new machine is expected to generate net annual
earnings of Rs. 120,000 (before depreciation & tax). The firm depreciates its assets @ 25%
W.D.V. and there is no other asset in the same block of asset. Evaluate the replacement
proposal given that the tax rate is 40% and cost of capital is 20%.

AU/TYBBA/16-17/Sem – V/CF Compiled by Prof. Pervin Gandhi