Capital Budgeting (Cash Flow)

Q. Assume the following facts relating to Avon Ltd (AL):

Block of Assets Depreciation rate WDV as on 1.4.2007 addition during 07-08

A 25 500 250

B 40 300 150

------------------------------------------------------------------------------------------------------------------Assets sold during 2007-08, amounted to Rs 35 lakh (Block A) and Rs 50 lakh (Block B). It is expected that fresh investments in assets during 2008-09 will be Rs 160 lakh in Block A and Rs 80 lakh in Block B. It is projected by AL that disinvestment proceeds from the assets will amount to Rs 45 lakhs in A and 25 lakhs in B. Assume that about 50% of additional investment during 08-09 will be made after September 08. Compute the relevant Depreciation charges for both the years.

Expansion (single- New block )

2. An iron ore company is considering in investing in a new processing facility. The company extracts ore from open pit mine. During a year 100000 tonnes of ore is extracted. If output from the extraction process is sold immediately upon removal of dirt, rocks and other impurities, a price of Rs 1000 per ton of ore can be obtained. The company has estimated that its extraction costs amount to 70 % of net realizable value of the ore.

As an alternative to selling all the ore at rs 1000 per tonne, it is possible to process further 25% of the output. The additional cash cost of further processing would be Rs 100 per ton, the processed ore would yield 80% final output, and can be sold at Rs 1600 per ton.

For additional processing, the company would have to install equipment costing Rs 100 lakhs. Equipment is subject to 20% depreciation on WDV basis. It is expected to have useful life of 5 years. Additional working capital requirements is estimated at Rs 10 lakhs. The cost of capital of company is 15% and effective tax rate is 35%. Assuming there is no other plant & machinery is subjects to 20 % depreciation. Should the company install the Equipment if,

a) Expected salvage value is Rs 10 lakhs.b) Expected salvage value is nil.

Replacement

3. Royal Industries Ltd is considering the replacement of one of its moulding machines. The existing machine is in good operating condition, but is smaller than required if the form is to expand its operation. It is 4 years old, has a current salvage value of rs 200,000 and remaining life of 6 years. The machine was initially purchased for Rs 10 lakhs and is being depreciated at 20% on the basis of WDV methods.

The new machine will cost Rs. 15 lakhs and subject to same rate and same method of depreciation. It is expected to have 6 years life and a Salvage Value of Rs 150, 000. Additional WC requirement will be 1 lakh. The revenue will increase by Rs 5 lakhs due to expansion. Variable Cost to Sales is 30%. Tax rate is 35%, Cost of capital is 10%. The company has several machine in the block of 20% depreciation. Should the company replace? If

a) Expected salvage value is Rs 150, 000.b) Expected salvage value is nil.