Q1. ABC Construction needs to purchase Machine A worth 5 million after every 5 years (perpetually).

ABC has just p

Machine A today. For subsequent purchases in the future, it also has an alternative to go for a different machine (M
can perform the same task. Machine B has a cost of 6 million and a life of 6 years. Assume the price of both machine
the same in the future. If the discount rate for ABC is 12% per annum, which machine should ABC choose to purchas

Since both machines have different lives we need to estimate EAC for each machine
Next purchase is due at year 5.

Correct Cashflow timelines for Machine A is a 5 year cashlow (perpetual) of 5million starting from year 5,
(perpetual) of 6million starting from year 5
Alternatively student may make cashflow timeline with EAC of A and B, in this case for both machines EA
they are annual and perpetual cashflows

EAC with 5 year life 1387048.66 (0.5 mark)

EAC with 6 year life 1459354.311 (0.5 mark)

Since EAC for Machine A is lower ABC should go for purchasing Machine A in future as well.

If the student has not made the cashflow timeline but arrived at the correct solution simply by estimating
ALTERNATE SOLUTION WITH PV OF COSTS OF BOTH MACHINES

Next purchase is due at year 5.

Five year interest rate 76.23%

(0.5 mark)
Six year interest rate 97.38%

PV of costs with Machine A 6558738.831 (0.5 mark)

PV of costs with Machine B 6900640.232 (0.5 mark)

Since the PV of costs with A is lower ABC should purchase Machine A in future as well
 perpetually). ABC has just purchased a new
o for a different machine (Machine B) which
me the price of both machines would remain
hould ABC choose to purchase in the future

5million starting from year 5, and for machine B it is 6 year cashflow

(0.5 mark)
s case for both machines EAC start from year 6 (under usual assumptions) and

future as well. (0.5 mark)

solution simply by estimating EAC, please award full marks

(0.5 mark)
Q2. A project requires an investment of 5 million right now. There are only three possibilities that can happen in the
Possibility 1: Positive cash flow of 1 million every year starting year 1 till perpetuity
Possibility 2: Positive cash flow of 2 million every year starting year 1 till perpetuity
Possibility 3: Positive cash flow of 3 million every year starting year 1 till perpetuity
If the appropriate discounting rate is 10%, then find the NPV of investing in the project.

Possibility 1 PV 10
Possibility 2 PV 20 0.5 marks for getting at least one possib
Possibility 3 PV 30

NPV 15 1 mark
ilities that can happen in the project with equal probabilities.

or getting at least one possibiilities PV correct

Q3. There are three mutually exclusive projects A, B and C and the appropriate discounting rate for them is 10%
Cash Flow in Year 0 Cash flow in Year 1
Project A -17 million 20 million
Project B 13 million -17 million
Project C -5 million 5 million
i) find the IRR of the three projects given the discounting rate.
ii) Which project among the three will you select.

A IRR 17.65% 0.5 marks

B IRR 30.77% 0.5 marks
C IRR 0 0.5 marks

A NPV 1.18181818182 mn
B NPV -2.45454545455 mn
C NPV -0.45454545455 mn

Project A will be selected because NPV is positive

ting rate for them is 10%

1 Mark
Q4. ABC Ltd. is evaluating to replace its photocopying machine. Their existing machine has a
book value of 3 lakhs and remaining life of 3 years. They use straight line depreciation, and it
will have no book value at the end of its life. The machine can be sold today for 4 lakhs but if
they wait till the end of the machine’s life, it can be sold for only 50,000. A vendor has offered
them a new machine which will cost 6 lakhs today and has an economic life of 3 years. The
machine (depreciated on a straight line basis) will have a book value of 1.5 lakhs at the end of
its life and can be sold for 2.5 lakhs at the end of its life. ABC Ltd. gets 20,000 extra Gross Profit
(Revenue – COGS) every year from using the new machine. If the WACC for ABC Ltd. Is 10%,
what is the NPV for ABC’s decision to replace the machine? Assume tax rate is 30%.

Discount rate
Tax Rate

Replace Machine

Selling price of old machine

Gain on sale of machine
Tax on gain
Net CF from sale of old machine

Cost of new machine

Depreciation from new machine
Tax shield from depreciation
Sale of new machine
Book value of new machine at end of its life
Gain on sale of machine
Tax on gain
CF from sale of machine
Extra cash-flow from new machine
Net cash-flows on replacement

Don't replace machine

Depreciation of old machine
Tax shield from old machine depreciation
Sale of old machine if not replaced
Gain
Tax on gain
Net CF from sale of machine
Net CF if machine is not replaced

Incremental cash-flows from replacement

NPV

Note: If a student compared the NPV of the two decisions (Replace Vs not replace) separately
to come out with correct answer, that is also correct and deserves full marks as long as the
cash-flows are correctly identified and measured
10%
30%

0 1 2 3

400
100
30
370

-600
150 150 150
45 45 45
250
150
100
30
220
14 14 14
-230 59 59 279

100 100 100

30 30 30
50
50
 15
35
30 30 65

-230 29 29 214

-18.89
0.5 marks

0.5 marks

0.5 marks

0.5 marks

0.5 marks
0.5 marks

0.5 marks

0.5 marks