Capital Budgeting Problems

1. Cost of a plant is Rs 4,00,000. It has an estimated life of 4 years . PBDIT is determined to beRs 1,95,000 p.a. Tax rate applicable is 30%. Calculate yearly cash flow generated from the plant.

2. A company is evaluating a capital budgeting proposal. The following data is available in this regards.Cost of Plant – Rs 12,00,000Installation cost – Rs 4,600Economic Life – 8 yearsScrap Value Rs 50,000PBDIT Rs 3,50,000Tax Rate – 50%Calculate yearly cash flow

3. XYZ is coming out with a new product range. The production equipment will cost Rs 6,40,000. The life is expected to be 8 years. Selling price per pack of 50 gms is INR 12. Variable cost would be Rs 8 and fixed cost per annum would be Rs 2,00,000. Fixed cost includes depreciation of INR 80,000 and share of existing overheads Rs 20,000.The company expects to sell 100,000 packs per year. Tax rate applicable is 40%. Determine the yearly cash flow.

4. A textile company is considering two mutually exclusive investment proposals for its expansion program. Proposal A requires an initial investment of Rs 7,50,000 and yearly operating costs of Rs 50,000. Proposal B requires an initial investment of Rs 5,00,000 and yearly operating costs of Rs 100,000. The life of the equipment used in both the investment proposals will be 12 years with no salvage value; depreciation is on straight line basis. The anticipated increase in revenues is Rs. 1,50,000 per year in both investment proposals. The tax rate is 35 per cent and cost of capital is 15 percent. Which investment proposal should be undertaken by the company using NPV, Payback period and IRR. What would you recommend?

5. A firm is evaluating purchase of new software which costs Rs 20 lakhs and has a useful lifespan of four years. The operational cost associated with the software, is estimated to be Rs 1.5 lakh per annum; it is expected to bring in an income of Rs 4.5 lakh per annum and reduce costs by Rs 80,000 per annum. Calculate the NPV , Payback period, discounted pay back period and IRR of the project. Tax rate is 30% and the appropriate opportunity cost of capital is 12% for this firm.

6. Sandals inc, is considering the purchase of a new leather cutting machine to replace and existing machine that has a book value of Rs 3000 and can be sold for Rs 1,500. The estimated salvage value of the old machine in four years would be zero and it is depreciated on a straight line basis. The new machine will reduce costs (before tax) by Rs. 7000 per year, i.e. Rs 7000 cash savings over the old machine. The new machine has a four year life. Cost Rs. 14,000 and can be sold for an expected amount of Rs 2,000 at the end of the fourth year. Assuming straight line depreciation, and a 40% tax rate, define the cash flows associated with the investment. Assume that the straight line method of depreciation is used for tax purposes.

7. Pilot plus pens is deciding when to replace its old machine. The machine’s current salvage value is Rs 2 million. Its current book value is Rs 1 million. If not sold, the old machine will require maintenance cost of Rs 400,000 at the end of the year for the next five years. Depreciation on the old machine is Rs 200,000 per year. At the end of five years, it will have a salvage value of Rs 200,000 and a book value of 0. A replacement machine costs Rs 3 million now and requires maintenance cost of Rs 500,000 at the end of each year during its economic life of five years. At the end of five years, the new machine will have a salvage value of Rs 500,000. It will be fully depreciated using the straight line method. The corporate tax rate is 34% and the appropriate discount rate is 12%. Should Pilot Pen replace the old machine?

8. RST Ltd is evaluating two mutually exclusive proposals. Machine A and Machine B, Initial Capital Ouutlay required for these two machines are Rs 1,40,000 and Rs 2,50,000 respectively. Subsequent Annual Inflows are:

Year 1

Year 2

Year 3 Year 4 Year 5

Year 6

Machine A

10,000

20,000

1,30,000

70,000 20,000

30,000

Machine B

70,000

80,000

90,000 100,000

50,000

40,000

Given that the required rate of return is 15%, find out the NPV and PI of both proposals. Which proposal should be taken up by the firm?

9. Ojus 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 400,000 and it can be sold to realise a post tax salvage value of R500,000. It has a remaining life of five years after which its net salvage value is expected to be Rs 160,000. It is being depreciated annually at a rate of 25 % under the written down value method. The working capital required for the old machine is Rs 400,000.The new machine costs Rs 1,600,000. It is expected to fetch a net salvage of Rs 800,000 after 5 years when it will no longer be required. The depreciation rate applicable to it is 25% under the written down value method. The net working capital required for the new machine is Rs 500,000. The new machine is expected to bring a saving or Rs 400,000 annually in manufacturing costs (other than depreciation). The tax rate applicable to the firm is 40%.Work out the incremental after-tax cash flows for the replacement project.