CASE DISCUSSION

FREE CASHFLOW
TIMELINE

TEMPLATE
REVENUE
COSTS
DEPRECIATION
EBIT
LESS: TAXES
EBIAT/NOPAT
ADD: DEPRECIATION
OPERATING CASH FLOW

LESS: CAPITAL EXPENDITURE

COST OF MACHINE

LESS: INCREEMENTAL NET WORKING CAPITAL

SALE PRICE OF MACHINE
TAXES ON PROFIT/LOSS ON SALEOF MACHINE
TAXES*(BOOK VALUE-SALE PRICE):0.40*(0-75000)
FREE CASH FLOW

net present value at 8%

SCALE BIAS Profitability Index

Internal rate of return 19.6988%
ACCEPT BECAUSE IRR HERE IS GREATER THAN 8%
Long life bias
Payback period
Cumulative cash flow
Payback period 3.125 3+(20,000/16,000)
ACCEPT IF TARGET PERIOD > 4 YEARS
REJECT IF TARGET PERIOD IS 3 YEARS
MAX FREE CASH FLOW
MAX DEP TAX SHIELD=DEP*TAX RATE

TIMELINE Project A Project B

0 -3000 -4500
 1 950 750
2 1200 975
3 1250 1350
4 1300 1400
5 1450
6 1500

NPV AT 10% ₹ 682.43 ₹ 705.14

EQUIVALENT ANNUAL ANNUITY/EQUIVALENT

ANNUAL COST ₹ 215.29 ₹ 161.91
Accept A
.
TIME CASHFLOW
0 -17000
1 16000
2 16000
3 16000
4 16000
5 -52000

COMPUTE IRR 6.77% NPV = 0

COMPUTE NPV AT 65.36% ₹ -0.08 IRR = 65.36%
ACCEPT IRR > DISCOUNT RATE /OPPORTUNITY
COST OF CAPITAL
MULTIPLE IRR PROBLEM No of times the size of the cashflow changes
 85000
100000
T0 T1 T2 T3 T4 T5

200000 200000 200000 200000 200000

100000 100000 100000 100000 100000
100000 100000 100000 100000 100000
40000 40000 40000 40000 40000
60000 60000 60000 60000 60000
100000 100000 100000 100000 100000
160000 160000 160000 160000 160000

-500000

75000

-30000 ₹ 29,019.69
-500000 160000 160000 160000 160000 205000

₹ 169,459.85 Accept

₹ -500,000.00 -340000 -180000 -20000 140000 345000

ACCEPT B

PMT
 FADM METHOD (ACCOUNTING GROOVES)
200000 200000 200000 200000 200000
85000 85000 85000 85000 85000
115000 115000 115000 115000 115000
46000 46000 46000 46000 46000
69000 69000 69000 69000 69000
85000 85000 85000 85000 85000
154000 154000 154000 154000 154000

ANNUAL TAX SAVINGS 6000 YEARLY

15000*0.40 6000
CHANGE IN DEP*TAX RATE

DEP IN FADM 85000

DEP IN FM 100000
Machine cost 20 0.2 0.32
Building cost 150 0.026 0.05
2012 2013 2014

sales units 1.2 1.6

SALES PRICE PER UNIT 115 115
Revenue 138 184
Cannibalization Loss 35 15
NET REVENUE 103 169
Variable Costs 56.65 92.95
Depreciation (Building) 3.9 7.5
Depreciation (Machinery) 4 6.4
Selling General and Admin Expenses 7 7
Endorsement 2 2
Advertising and Promotion 25 15
RESEARCH AND DEVELOPMENT
EBIT 4.45 38.15
TAXES AT 40% 1.78 15.26
EBIAT/NOPAT 2.67 22.89
Depreciation (Building) 3.9 7.5
Depreciation (Machinery) 4 6.4
OPERATING CASH FLOW 10.57 36.79
CAPITAL EXPENDITURE
COST OF BUILDING -150
COST OF MACHINERY -20
INCLUDING INSTALLATION
SALE PRICE OF BUILDING
SALE PRICE OF MACHINERY
TAX ON PROFIT / SALE BUILDING
TAX ON PROFIT / SALE MACHINERY
INCREMENTAL NET WORKING CAPITAL -10 -1.0725 -7.095 0.86
RECOVERY OF NET WORKING CAPITAL
FREE CASH FLOW = OCF-CAPEX-INWC -180 9.4975 29.695 37.27

IRR 13%
DISCOUNT RATE 11%
NET WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABLITIES
CURRENT ASSETS ( CASH OUTFLOWS)
INVENTORY -15 -14.1625 -23.2375 -22.1375
RECEIVABLES -8.24 -13.52 -12.88
CASH

CURRENT LIABLITIES (CASH INFLOWS)

TRADE PAYABLES 5 11.33 18.59 17.71

Net working capital -10 -11.0725 -18.1675 -17.3075

Doubt
 0.19 0.12 0.11 0.06
0.047 0.045 0.043 0.04
2015 2016 2017 2018

1.4 2.4 1.8 0.9

115 115 115 115
161 276 207 103.5

161 276 207 103.5

88.55 151.8 113.85 56.925 55% of the net revenue
7.05 6.75 6.45 6
3.8 2.4 2.2 1.2
7 7 7 7
2 3 2 2
10 30 25 15
SUNK COST - IRREVERSIBLE COST
42.6 75.05 50.5 15.375
17.04 30.02 20.2 6.15
25.56 45.03 30.3 9.225
7.05 6.75 6.45 6 37.65
3.8 2.4 2.2 1.2 20
36.41 54.18 38.95 16.425

102
3
4.14 BOOK VALUE OF BUILDING
-1.2 112.35 (150-37.65)
-12.3625 7.4175 11.12625 BOOK VALUE OF MACHINERY
11.12625
41.8175 46.3675 146.6175
0
VALUES ARE WRONG JUST FOCUS ON THE METHOD

-37.95 -28.4625 -14.23125

-22.08 -16.56 -8.28

30.36 22.77 11.385

-29.67 -22.2525 -11.12625

 Not our concern since it is a non-tax expense

TIMELINE 0 1 2
REVENUE
COST SAVINGS ₹ 25,000.00 ₹ 25,000.00
LABOUR SAVINGS ₹ 135,000.00 ₹ 135,000.00
FLOOR SPACE
EBITDA ₹ 160,000.00 ₹ 160,000.00
DEPRECIATION ON NEW MACHINE ₹ 40,000.00 ₹ 40,000.00
LOST DEPRECIATION ON OLD MACHINE (Saving) ₹ 20,000.00 ₹ 20,000.00
EBIT ₹ 140,000.00 ₹ 140,000.00
TAXES 40% ₹ 56,000.00 ₹ 56,000.00
EBIAT/NOPAT ₹ 84,000.00 ₹ 84,000.00
ADD NET DEPRECIATION ₹ 20,000.00 ₹ 20,000.00
OPERATING CASH FLOW ₹ 104,000.00 ₹ 104,000.00
CAPITAL EXPENDITURE
COST OF NEW MACHINE ₹ -480,000.00
SALE OF OLD MACHINE ₹ 100,000.00
TAX ON PROFIT/LOSS ON SALE OF OLD MACHINE ₹ 56,000.00
SALE OF NEW MACHINE
TAX ON PROFIT/LOSS ON SALE OF NEW MACHINE
CAPITAL EXPENDITURE
INCREMENTAL NET WORKING CAPITAL
FREE CASH FLOW ₹ -324,000.00 ₹ 104,000.00 ₹ 104,000.00
BOOK VALUE OF OLD MACHIN
IRR 30.82%
DISCOUNT RATE = 7% REPLACE THE MACHINE
NPV AT 7% ₹ 502,039.37

YEAR PROJECT X PROJECT Y

0 -3000 -800
1 1200 850
2 1400 950
3 1600 1000
4 1800 1050
5 1900 1075

USE IRR AS EVALUATION CRITERIA 40% 111%

ce it is a non-tax expense

3 4 5 6 7 8 9

₹ 25,000.00 ₹ 25,000.00 ₹ 25,000.00 ₹ 25,000.00 ₹ 25,000.00 ₹ 25,000.00 ₹ 25,000.00

₹ 135,000.00 ₹ 135,000.00 ₹ 135,000.00 ₹ 135,000.00 ₹ 135,000.00 ₹ 135,000.00 ₹ 135,000.00

₹ 160,000.00 ₹ 160,000.00 ₹ 160,000.00 ₹ 160,000.00 ₹ 160,000.00 ₹ 160,000.00 ₹ 160,000.00

₹ 40,000.00 ₹ 40,000.00 ₹ 40,000.00
₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00
₹ 140,000.00 ₹ 140,000.00 ₹ 140,000.00
₹ 56,000.00 ₹ 56,000.00 ₹ 56,000.00
₹ 84,000.00 ₹ 84,000.00 ₹ 84,000.00
₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00
₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00
₹ 40,000.00 ₹ 40,000.00 ₹ 40,000.00 ₹ 40,000.00
₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00
₹ 140,000.00 ₹ 140,000.00 ₹ 140,000.00 ₹ 140,000.00
₹ 56,000.00 ₹ 56,000.00 ₹ 56,000.00 ₹ 56,000.00
₹ 84,000.00 ₹ 84,000.00 ₹ 84,000.00 ₹ 84,000.00
₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00
₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00

₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00

OK VALUE OF OLD MACHINE - SALE OF OLD MACHINE = 140000

PROJECT Z
-8 THE SMALLER THE PROJECT THE GREATER THE IRR
8.5 IRR DOES NOT ACCOUNT FOR THE SCALE OF THE CASH FLOWS
9.5
10
10.5
10.75

111%
 10 11 12

₹ 25,000.00 ₹ 25,000.00 ₹ 25,000.00

₹ 135,000.00 ₹ 135,000.00 ₹ 135,000.00

₹ 160,000.00 ₹ 160,000.00 ₹ 160,000.00

₹ 40,000.00 ₹ 40,000.00 ₹ 40,000.00
₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00
₹ 140,000.00 ₹ 140,000.00 ₹ 140,000.00
₹ 56,000.00 ₹ 56,000.00 ₹ 56,000.00
₹ 84,000.00 ₹ 84,000.00 ₹ 84,000.00
₹ 20,000.00 ₹ 20,000.00 ₹ 20,000.00
₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00

₹ 104,000.00 ₹ 104,000.00 ₹ 104,000.00