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BBA SEM VI: Advance Financeial Management

Problem 9
Satya corporation is toying with the idea of replacing its existing machine. The following
are the relevant data
1. Existing Machine

2. New machine

Purchased 2 years ago


Capital cost of Rs 8,000
Remaining life 6 years
Estimated useful life 6 years
Salvage value Rs 500
Estimated salvage value Rs 800
Current book value Rs 2,600 and its
realisable market value Rs 3,000
Annual depreciation Rs 350
The replaced machine would permit an output expansion. As a result, sales is expected to
rise by Rs 1,000 per year, operating expenses would decline by Rs 1,500 per year. It
would require an additional inventory of Rs 2,000
Assuming corporate tax rate of 40% and cost of capital of 15%, advice the company
Problem 10
A large profit making company is considering the installation of a machine to process the
waste produced by one of its existing manufacturing process to be converted into a
marketable product. At present, the waste is removed by a contractor for disposal on
payment by the company of Rs 50 lacs per annum for next 4 years. The contract can be
terminated on installation of the aforesaid machine on payment of a compensation of Rs
30 lakhs before the processing operation starts. This compensation is not allowed as
deduction for tax purposes.
The machine required for carrying out the processing will cost Rs 200 lakhs to be
financed by a loan repayable in 4 equal instalments commencing from the end of year 1.
The interest rate is 16% p.a At the end of 4 th year, the machine can be sold for Rs 20
lakhs and the cost for dismantling and removal will be Rs 15 lakhs.
Sales and direct cost of the product emerging from waste processing for 4 years are
estimated as under:
Sales
Material consumption
Wages
Other expenses
Factory overheads
Depreciation ( As per income tax)

1
322
30
75
40
55
50

2
322
40
75
45
60
38

3
418
85
85
54
110
28

4
418
85
100
70
145
21

Initial stock required before commencement of the processing operations is Rs 20 lacs at


the start of year 1. The stock levels of materials to be maintained at the end of year 1,2
and 3 will be Rs 55 lacs and the stock at the end of year 4 will be nil. The storage of
Prepared By: Mahendra Patel, Parul Institute of Business Administration

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BBA SEM VI: Advance Financeial Management


material will utilise the space which otherwise would have been rented out for Rs 10 lakhs
per annum. Labour cost includes wages of 40 workers, whose transfer to this process will
reduce idle time payments of Rs 15 lacs in year 1 and Rs 10 lacs in year 2. Factory
overheads include apportionment of general factory overheads except to the extent of
insurance charges of Rs 30 lakhs per annum attributable to this venture.The companys
tax rate is 50% for revenue incomes.
Advice the management on the desirability of installing the machinery for processing the
waste. All calculation should form part of the answer. Required rate of return is 15%.
Problem 11
A company is setting up a plant at a cost of Rs 300 lakhs of investment in fixed assets. It
has to decide whether to locate the plant in a forward area (FA) or backward are (BA).
Locating in backward area means a cash subsidy of Rs 15 lakhs from the central
government. Besides the taxable profit to the extent of 20% is exempt for 10 years. The
project envisages a borrowing of RS 200 lakhs in either case. The cost of borrowing will
be 12% in forward area and 10% in backward area. However the revenue costs are
bound to be higher in the BA. The borrowing principle has to be repaid in 4 equal annual
instalments beginning from the end of year 4. With the help of following information and
by using Discounted Cash Flow technique you are required to suggest proper location for
the project. Assume straight-line depreciation with no residual value.
Earning before interest and tax (Rs in lakhs)
Year
FA
BA

1
-6
-50

2
34
-20

3
54
10

4
74
20

5
108
45

6
142
100

7
156
155

8
230
190

9
330
230

10
430
330

Assume
1. Discounting rate to be 15%
2. Rate of Income tax to be 50%
3. Central subsidy is not to affect depreciation or tax.
4. No other relief and rebates will be available to the company other than those
mentioned above.
Problem 12
X ltd. is considering two mutually exclusive projects X and Y. Following details are made
available to you:
Rs. In lacs

Project cost
Cash inflows
Year

Project Project
X
Y
1,000
1,000

Prepared By: Mahendra Patel, Parul Institute of Business Administration

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BBA SEM VI: Advance Financeial Management


1
2
3
4
5

200
150
320
450
500

200
600
250
100
150

Assume no residual value at the end of fifth year. The firms cost of capital is 10%.
Required, in respect of each of the two projects:
i. NPV using 10% discounting rate
ii. IRR and
iii. Profitability index
iv. Payback period
Problem 2
A company proposes to undertake two mutually exclusive projects AXE and BXE :
Initial capital outlay
Economic life (years)
After tax annual cash inflows
Year
1
2
3
4
5
6
7

AXE
Rs 22,50,000
4
6,00,000
12,50,000
10,00,000
7,50,000
-

BXE
Rs. 30,00,000
7
5,00,000
7,50,000
7,50,000
12,00,000
12,50,000
10,00,000
8,00,000

The companys cost of capital is 16%. Please calculate the net present value and IRR for
both the projects
Problem 3
Precision instruments is considering two mutually exclusive projects X and Y. Following
details are made available to you :
Rs. In lacs
Project X
Project Y
Project cost
Cash inflows
Year
1
2
3

700

700

100
200
300

500
400
200

Prepared By: Mahendra Patel, Parul Institute of Business Administration

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BBA SEM VI: Advance Financeial Management


4
5

450
600

100
100

Assume no residual value at the end of fifth year. The firms cost of capital is 10%.
Required, in respect of each of the two projects :
i. NPV using 10% discounting rate
ii. IRR and
iii. Profitability index
Problem 12
X ltd. is considering two mutually exclusive projects X and Y. Following details are made
available to you :
Rs. In lacs
Project X
Project Y
Project cost
Cash inflows
Year
1
2
3
4
5

1,000

1,000

200
150
320
450
500

200
600
250
100
150

Assume no residual value at the end of fifth year. The firms cost of capital is 10%.
Required, in respect of each of the two projects:
i. NPV using 10% discounting rate
ii. IRR and
iii. Profitability index
iv. Payback period
Problem 13
A company is considering as to which of two mutually exclusive projects it should
undertake. The finance directors thinks that the project with the higher NPV should be
chosen whereas the managing director thinks that the one with higher IRR should be
undertaken especially as both the projects have the same initial outlay and length of life.
The company anticipates a cost of capital of 10% and the net after tax cash flows of the
project are as follows
Year
Project X
Project Y
0
(200)
(200)
1
35
218
2
80
10
3
90
10
4
75
4
5
20
3

Prepared By: Mahendra Patel, Parul Institute of Business Administration

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BBA SEM VI: Advance Financeial Management


Required
1. Calculate the NPV and IRR of each project
2. state with reasons which project you would recommened
The discounting factors are as follows
Year
1
2
3
4
5

10%
0.91
0.83
0.75
0.68
0.62

Prepared By: Mahendra Patel, Parul Institute of Business Administration

20%
0.83
0.69
0.58
0.48
0.41

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