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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
Cost of capital( Real) 0.08
Discounting factor 1.00 1.00 1.00 1.00 1.00
Present Value 3.53 3.18 3.18 3.18 3.18
Present Value of cash flow -14.2 30.02
Net Present Value 15.82
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
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 1.77Tax (@ 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
Cost of capital( Real) 0.08
Discounting factor 0.92 0.85 0.79 0.73 0.67
Present Value 3.26 2.71 2.50 2.31 2.14
Present Value of cash flow -14.2 22.32
Net Present Value 8.12
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
On machinery 1 0 0 0 0
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
Cost of capital( Real) 0.08
Discounting factor 0.92 0.85 0.79 0.73 0.67
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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