Cap Budgeting Sums

8/6/2019 Cap Budgeting Sums

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Question 2

The procedure used is incorrect.The value of alternative use of land should be taken intoconsideration.

This will help in deciding if the building of the funeral house is moreprofitable or selling off the land.

Thus the value of the land i.e.$ 45,000 should be considered in theNPV analysis of Funeral House.


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Question 4

Option 1: Expense installation costs

Capitalized cost of kiln 3500000

Expensed instllation costs 500000

YEAR 1 2 3 4 5Depreciation on kiln 525000 446250 379313 322416 274053

Depn Tax Shield -176715 -150208 -127677 -108525 -92246

Installation costs 500000 0 0 0 0

Tax Shield on Installation -168300

After Tax Cost 154985 -150208 -127677 -108525 -92246

DF 0.87 0.76 0.66 0.57 0.50

Discounted Cash Outflows ### ### ### ### ###

PV of Cash Outflow ###

Option 2: Capitalize installation costs

Capitalized costs 4000000

YEAR 1 2 3 4 5

Depreciation on kiln 600000 510000 433500 368475 ###

Depn Tax Shield -201960 -171666 -145916 -124029 -105424

DF 0.87 0.76 0.66 0.57 0.50

Discounted Cash Outflows ### ### -95942.2 -70913.8 ###PV of Cash Outflow ###

If we capitalize installation cost completely, the PV of cash outflow is lesser.


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61552969

-522729

0

-522729

0.43

###

6

###

-597405

0.43

-258274.6


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Question -7

Year 0 1 2 3

Capital Investment -150000

Working Capital -30000

Incremental Cash Inflow 100000 100000 100000

(-) Depreciation 21429 21429 21429

PBT 78571 78571 78571(-)Tax 27500 27500 27500

PAT 51071 51071 51071

Net Cash Flow 72500 72500 72500

Discounted Cash Flow 63043 54820 47670

Working capital

PV of Working Capital

Present Value 364839

Net Present Value 184839

Since NPV is a positive value, plant manager's proposal can be

However Working Capital cannot be ignored as suggested by the Plant

Working Capital Should be shown as an outflow in the 1st year and as


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4 5 6 7 8 9 10

100000 100000 100000 100000 100000 100000 100000

21429 21429 21429 21429

78571 78571 78571 78571 100000 100000 10000027500 27500 27500 27500 35000 35000 35000

51071 51071 51071 51071 65000 65000 65000

72500 72500 72500 72500 65000 65000 65000

41452 36045 31344 27255 21249 18477 16067

30000

7416

accepted.

Manager.

an Inflow in the last year when operations close.


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Question -9

Nominal Int Rate 9%

Inflation 3%

Real Int Rate ((1.09/1.03)-1) 5.83%

Year 0 1 2 3 4Investment -35000

Savings 8580 8580 8580 8580

Cost -2253 -2253 -2253 -2253

Cash flows 6327 6327 6327 6327

Salvage value (Real terms)

PV at 5.83 % 5978 5649 5338 5044

PV of Salvage at 5.83 %

NPV 14088

Positive NPV suppports the new strategy adopted.

Notes:

Savings= 26*(200+40+90)

Cost = (26*0.45*90)+1200

We have assumed that the transporter is rented every alternate week for one d

The average miles per trip has been considered (i.e., average of 80 and 100)

Since, the cashflows remain constant every year, we have assumed that they aThus we have used the Real Interest Rate for discountinf purpose.


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5 6 7 8

8580 8580 8580 8580

-2253 -2253 -2253 -2253

6327 6327 6327 6327

15000

4766 4503 4255 4021

9533

ay.

re all real cashflos.


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Question 10

Year 0 1 2 3

Initial Investment 1200000

Working Capital Investme 350000 70000 21000 22050

Sales 4200000 4410000 4630500

Manufacturing Costs(90%) 3780000 3969000 4167450Rent (Opportunity Cost) 100000 104000 108160

Depreciation 120000 120000 120000

PBT 200000 217000 234890

Tax @ 35% 70000 75950 82212

PAT 130000 141050 152679

(+) Depreciation 120000 120000 120000

Cashflow After Tax 250000 261050 272679

Salvage valueTax on Salvage Value

Release of WC

Final Cashflows -1550000 180000 240050 250629

Discounted Cash flows 160714 191366 178392

1635796

NPV at 12 % 85796

Notes:

Book Value of Plant at the end of 8 years = 240000

Selling Price = 400000

Profit on Sale = 160000

Tax Shield on Gain = 56000


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4 5 6 7 8

23153 24310 25526 26802 28142

4862025 5105126.25 5360382.56 5628401.69 5909821.78

4375822.5 4594613.63 4824344.31 5065561.52 5318839.6112486.4 116985.86 121665.29 126531.9 131593.18

120000 120000 120000 120000 120000

253716.1 273526.77 294372.97 316308.27 339389

88801 95734 103031 110708 118786

164915 177792 191342 205600 220603

120000 120000 120000 120000 120000

284915 297792 311342 325600 340603

400000-56000

590982

261763 273482 285817 298798 1247443

166355 155181 144804 135161 503821


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Question 13

Case 1: Old machinery being sold

(In $) 1 2 3 4 5

Cash Inflow 25000

Operating Costs before overhauling 20000 20000 20000 20000 20000

Overhauling Expenses 20000

Operating Costs after overhaulingDepreciation

Total Cost incurred 20000 20000 20000 20000 40000

less: Tax sheild on depreciation @35%

Cash outflows 20000 20000 20000 20000 40000

Scrap Value received

Net cash flows 5000 -20000 -20000 -20000 -40000

Present value factor (Cost of capital @12 0.89 0.8 0.71 0.64 0.57

Present value of cash flows 4464.29 ### -14235.6 ### ###

Net Present value ###

Case 2: New machinery being sold

(In $) 1 2 3 4 5

Cash Inflow 50000

Overhauling Expenses -20000

Operating Costs after overhauling -30000 -30000 -30000 -30000 -30000

Depreciation -3000 -3000 -3000 -3000 -3000

Total Cost incurred -53000 -33000 -33000 -33000 -33000

less: Tax sheild on depreciation @35% 1050 1050 1050 1050 1050

Cash outflows -51950 -31950 -31950 -31950 -31950Scrap Value received 5000

Net cash flows -1950 -31950 -31950 -31950 -26950

Present value factor (Cost of capital @12 0.89 0.8 0.71 0.64 0.57

Present value of cash flows -1741.07 ### ### -20304.8 ###

Net Present value ###

so, we will sell of the new mchinery


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6 7 8 9 10

30000 30000 30000 30000 300003000 3000 3000 3000 3000

33000 33000 33000 33000 33000

1050 1050 1050 1050 1050

31950 31950 31950 31950 31950

5000

-31950 -31950 -31950 -31950 -26950

0.51 0.45 0.4 0.36 0.32

### ### ### ### -8677.18


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Question 14

Old machinery 1 2 3 4 5 6

Maitainance Cost 2000 2000 8000 8000 8000 8000

Book Value of m/c 10440.13 8874.11 7542.99 6411.54 5449.81 4632.34

Depreciation 1566.02 1331.12 1131.45 961.73 817.47 694.85

Total cost 3566.02 3331.12 9131.45 8961.73 8817.47 8694.85

Tax shield@35% 548.11 465.89 396.01 336.61 286.12 243.2Cash outflows 3017.91 2865.23 8735.44 8625.13 8531.36 8451.65

PV factor @7% 0.93 0.87 0.82 0.76 0.71 0.67

PV of cash outflows 2820.48 2502.6 7130.72 6580.07 6082.74 5631.69

New machinery

Maitainance Cost 1000 1000 1000 1000 1000 1000

Book Value of m/c 25000 21250 18062.5 15353.13 13050.16 11092.63

Depreciation 3750 3187.5 2709.38 2302.97 1957.52 1663.89

Total cost 4750 4187.5 3709.38 3302.97 2957.52 2663.89

Tax shield@35% 1312.5 1115.63 948.28 806.04 685.13 582.36Cash outflows 3437.5 3071.88 2761.09 2496.93 2272.39 2081.53

Capital outflow 17000 17000 21500 21500 21500 21500

PV factor@7% 0.93 0.87 0.82 0.76 0.71 0.67

PV of cash outflows 3212.62 2683.09 2253.87 1904.9 1620.18 1387.01

PV of capital outflow 17000 15887.85 18778.93 17550.4 16402.25 15329.2

`

Since the present value of cash outflows is minimum in the 2nd case, hence it make


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Replacing in the year

1 2 3 4 5 6

Cash outflow 30061.68 ### 31267.98 34916.3 38443.31 41832.82

sense for Hayden Inc. to replace the old machinery at the beginning of the 2nd year.


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Question 17

a.

PV of machine A 40000+ 10000/1.06 + 10000(1.06^2) + 10000/(1.06^3)

$ 66730.119

Annuity or annual rent payment for 3 years for a machine having PV = $66730.119Discount rate = 6%

No of payments = 3

Annuity = -$24,964.39

PV of machine B 50000 + 8000/1.06 + 8000(1.06^2) + 8000/(1.06^3) + 8000/(1.0

$77720.83831

Annuity or annual rent payment for 4 years for a machine having PV = $77720.8383

Discount rate = 6%No of payments = 4

Annuity = -$22,429.57

b.

Borstal should buy machine B as the annual rent to be paid on it is lesser i.e.

Annuity on mach. A = $ 24964.39 > Annuity on mach. B = $22429.57

c.

Taking inflation rate = 8% we recompute costs

Year

0 40000 40000 50000 50000

1 10000 8000

2 10000 8000

3 8000

4 8000

Mach. Acosts

InflatedCosts

Mach Bcosts

InflatedCosts

10000*1.08 = 10800

8000*1.08 = 8640

10000*1.08^2 =11664

8000*1.08^2 =9331.2

10000 +replace

10000*1.08^3 =12597.12

8000*1.08^3 =10077.696

8000*1.08^4 =10883.91


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Nominal interest rate will be considered for discounting

1 + Nominal interest rate = (1 + real int. Rate)* (1 + inflation rate)

Nominal Int. Rate = 1.06*1.08 1

14.48%

PV of Machine A 40000 + 10800/1.1448 + 11664/(1.1448^2) + 12597.12/(1.1448=$ 66730.11283

Annual rental for machine A for each of the 3 years @ 14.48% nominal discount rate

Annuity = -$28,974.54

PV of Machine B = 50000 + 8640/1.1448 + 9331.2/(1.1448^2) + 10077.696/(1.1448

=$ 77720.837

Annual rental for machine B for each of the 4 years @ 14.48% nominal discount rateAnnuity = -$26,937.08

After marking up the payments to cover for inflation, Borstal should still prefer to bu


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^4)

1


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3)

is:

^3) + 10883.91/(1.1448^4)

is:

Machine B as its annual rent is lower.


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Question 18

Suppose a technological change is expected to reduce the costs by 10% per year from the f

Year Mach A costs Mach B costs

0 40000 - 50000 -

1 10000 8000

2 10000 8000

3 7290 8000 5832

4 5249

PV of machine A 40000 + 9000/1.06 + 8000/1.06^2 + 7290/1.06^3

$61820

Annuity or annual rent payment for 3 years for a machine having PV = $61820

Discount rate = 6%

No of payments = 3

Annuity = -$17,840.73

PV of machine B 50000 + 7200/1.06 + 6480/1.06^2 + 5832/1.06^3 + 5249/1.06^4

$ 71613

Annuity or annual rent payment for 4 years for a machine having PV = $ 71613

Discount rate = 6%

No of payments = 4

Annuity = -$20,666.90

Costs after tech.Changes

Costs after tech.Changes

10000*(.9)=9000

8000*(.9) =7200

9000*(.9)=8100

7200*(.9) =6480

10000 +replace

8000+replace


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ollowing years.


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New Economy Transport (A)

Nominal Interst Rate 11%

Inflation 2.50%

Real Interest Rate 8.29%

OPTION 1

WITHOUT ENGINE

Year 0 1 2 3 4 5

Initial Outlay 8.2

Sales 14 14 14 14 14

Less:

Operating costs 11.81 11.81 11.81 11.81 11.81

EBITDA 2.19 2.19 2.19 2.19 2.19

Depreciation

On overhaul 1.17 1.17 1.17 1.17 1.17

On machinery 1 0 0 0 02.17 1.17 1.17 1.17 1.17

PBT 0.02 1.02 1.02 1.02 1.02

Tax (@ 35%) 0.01 0.36 0.36 0.36 0.36

PAT 0.01 0.66 0.66 0.66 0.66

CFAT -8.2 2.18 1.83 1.83 1.83 1.83

Cost of capital( Real) 0.08

Discounting factor 0.92 0.85 0.79 0.73 0.67

Present Value 2.02 1.56 1.44 1.33 1.23Present Value of cash flow -8.2 11.86

Net Present Value 3.66

OPTION 2

WITH ENGINE

Year Today 1 2 3 4 5

Initial Outlay 14.2

Sales 14 14 14 14 14

Less:

Operating costs 10.2 10.2 10.2 10.2 10.2

EBITDA 3.8 3.8 3.8 3.8 3.8

Depreciation

On overhaul 2.03 2.03 2.03 2.03 2.03

On machinery 1 0 0 0 0

3.03 2.03 2.03 2.03 2.03

PBT 0.77 1.77 1.77 1.77 1.77

Tax (@ 35%) 0.27 0.62 0.62 0.62 0.62


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PAT 0.50 1.15 1.15 1.15 1.15

CFAT 3.53 3.18 3.18 3.18 3.18



Present Value 3.53 3.18 3.18 3.18 3.18

Present Value of cash flow -14.2 30.02


OPTION 3

If Vital Sparks is sold off today

Inflow on Sale 2

Book Value of Vital Sparks 1

Book Value of Spare Parts 0.4

Gain on Sale 0.6

Tax on Gain 0.21

Net Cash Inflow 1.79

Hence we should go for Option 2, ie, Overhaul Vital Sparks with Engine.


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6 7 8 9 10

14 14 14 14 14

11.81 11.81 11.81 11.81 11.81

2.19 2.19 2.19 2.19 2.19

1.17 1.17 0.00 0.00 0.00

0 0 0 0 01.17 1.17 0.00 0.00 0.00

1.02 1.02 2.19 2.19 2.19

0.36 0.36 0.77 0.77 0.77

0.66 0.66 1.42 1.42 1.42

1.83 1.83 1.42 1.42 1.42

0.62 0.57 0.53 0.49 0.45

1.14 1.05 0.75 0.70 0.64

(In lakhs)

6 7 8 9 10

14 14 14 14 14

10.2 10.2 10.2 10.2 10.2

3.8 3.8 3.8 3.8 3.8

2.03 2.03 0.00 0.00 0.00

0 0 0 0 0

2.03 2.03 0.00 0.00 0.00

1.77 1.77 3.80 3.80 3.80

0.62 0.62 1.33 1.33 1.33


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1.15 1.15 2.47 2.47 2.47

3.18 3.18 2.47 2.47 2.47

1.00 1.00 1.00 1.00 1.00

3.18 3.18 2.47 2.47 2.47


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New Economy Transport (B)

Nominal Interst Rate 11%

Inflation 2.50%

Real Interest Rate 8.29%

(a) Overhauling and Operating Vital Spark for 12 years

Year 0 1 2 3 4 5Initial Outlay 14.2

Sales 14 14 14 14 14

Less:

Operating costs 10.2 10.2 10.2 10.2 10.2

EBITDA 3.8 3.8 3.8 3.8 3.8

Depreciation

On overhaul 2.03 2.03 2.03 2.03 2.03


3.03 2.03 2.03 2.03 2.03

PBT 0.77 1.77 1.77 1.77 1.77Tax (@ 35%) 0.27 0.62 0.62 0.62 0.62

PAT 0.50 1.15 1.15 1.15 1.15

CFAT 3.53 3.18 3.18 3.18 3.18



Present Value 3.26 2.71 2.50 2.31 2.14

Present Value of cash flow -14.2 22.32


Equivalent Annual Cost -1.09

(b) Buying and Operating proposed replacement vessel for 20 years

Year 0 1 2 3 4 5

Initial Outlay 15 15

Sales 15 15 15 15 15

Less:

Operating costs 8.85 8.85 8.85 8.85 8.85

Training Cost 0.5 0 0 0 0

EBITDA 5.65 6.15 6.15 6.15 6.15

Depreciation

On overhaul 1.50 1.50 1.50 1.50 1.50


2.50 1.50 1.50 1.50 1.50

PBT 3.15 4.65 4.65 4.65 4.65

Tax (@ 35%) 1.1 1.63 1.63 1.63 1.63


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PAT 2.05 3.02 3.02 3.02 3.02

CFAT -10.45 4.52 4.52 4.52 4.52



Present Value -9.65 3.86 3.56 3.29 3.04

Present Value of cash flow 15 29.63

NPV 14.63

Equivalent Annual Cost -1.52

Since Equivalent Annual Cost is lower in Case (a) it is better to overhaul and op


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(In lakhs)

6 7 8 9 10 11 12

14 14 14 14 14 14 14

10.2 10.2 10.2 10.2 10.2 10.2 10.2

3.8 3.8 3.8 3.8 3.8 3.8 3.8

2.03 2.03 0.00 0.00 0.00 0.00 0.00

0 0 0 0 0 0 0

2.03 2.03 0.00 0.00 0.00 0.00 0.00

1.77 1.77 3.80 3.80 3.80 3.80 3.800.62 0.62 1.33 1.33 1.33 1.33 1.33

1.15 1.15 2.47 2.47 2.47 2.47 2.47

3.18 3.18 2.47 2.47 2.47 2.47 2.47

0.62 0.57 0.53 0.49 0.45 0.42 0.38

1.97 1.82 1.31 1.21 1.11 1.03 0.95

6 7 8 9 10 11 12 13 14

15 15 15 15 15 15 15 15 15

8.85 8.85 8.85 8.85 8.85 8.85 8.85 8.85 8.85

0 0 0 0 0 0 0 0 0

6.15 6.15 6.15 6.15 6.15 6.15 6.15 6.15 6.15

1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50

0 0 0 0 0 0 0 0 0

1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50

4.65 4.65 4.65 4.65 4.65 4.65 4.65 4.65 4.65

1.63 1.63 1.63 1.63 1.63 1.63 1.63 1.63 1.63


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3.02 3.02 3.02 3.02 3.02 3.02 3.02 3.02 3.02

4.52 4.52 4.52 4.52 4.52 4.52 4.52 4.52 4.52

0.62 0.57 0.53 0.49 0.45 0.42 0.38 0.36 0.33

2.80 2.59 2.39 2.21 2.04 1.88 1.74 1.61 1.48

rate Vital Spark (with engine)


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15 16 17 18 19 20

15 15 15 15 15 15

8.85 8.85 8.85 8.85 8.85 8.85

0 0 0 0 0 0

6.15 6.15 6.15 6.15 6.15 6.15

1.50 1.50 1.50 1.50 1.50 1.50

0 0 0 0 0 0

1.50 1.50 1.50 1.50 1.50 1.50

4.65 4.65 4.65 4.65 4.65 4.65

1.63 1.63 1.63 1.63 1.63 1.63


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3.02 3.02 3.02 3.02 3.02 3.02

4.52 4.52 4.52 4.52 4.52 4.52

0.30 0.28 0.26 0.24 0.22 0.20

1.37 1.26 1.17 1.08 1.00 0.92

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