ASSIGNMENT 3
1. A company is faced with the problem of choosing between two mutually exclusive
projects. Project A requires a cash outlay of Rs. 1,00,000 and cash running expenses of
Rs. 35,000 per year. On the other hand, Project B will cost Rs. 1,50,000 and requires
cash running expenses of Rs. 20,000 per year. Both the machines have 8 years life.
Project A has a Rs. 4,000 salvage value and Project B has Rs. 14,000 salvage value. The
company's tax rate is 30% and has a 10% required rate of return. Assume depreciation
on straight-line basis and no tax on salvage values of assets. Find out the Initial, Annual
and Terminal cash flows on incremental basis.
2. BC Company is having difficulties with an automated machine having 4 years of
service life, its operating costs are fairly sizable compared to its revenues. For the next
four years, the revenues generated will be Rs. 5,20,000 annually and the annual cost
expenses will be Rs. 3,80,000. In addition, it must take depreciation of Rs. 80,000 per
year until the machine reaches zero book value. The machine could be sold today for
net cash of Rs. 80,000 which is less than its current book value of Rs. 1,60,000. The
firm's alternative is to invest in a new machine costing Rs. 4,00,000 and Rs. 80,000
installation expenses. The new machine would generate a revenue of Rs. 9,20,000 and
cash expense of Rs. 5,80,000. It would be depreciated over a 4-year period to a book
value of Rs. 1,60,000 at which time it could be sold for Rs. 1,40,000 net cash.
Depreciation would be provided as per straight-line and it requires additional Rs.
2,00,000 of inventory and receivables over the 4-year period. What is the differential
after tax cash flows stream for this proposal? (Tax rate may be taken at 30% for both
revenue & capital profits/ losses)
3. A cosmetic company is considering to introduce a new lotion. The manufacturing
equipment will cost Rs. 5,60,000. The expected life of the equipment is 8 years. The
company is thinking of selling the lotion at Rs. 12 each pack. It is estimated that variable
cost per pack would be Rs. 6 and annual fixed cost Rs. 4,50,000. Fixed cost includes
(straight-line) depreciation of Rs. 70,000 and allocated overheads of & 30,000. The
company expects to sell 1,00,000 packs of the lotion each year. Assume that tax is 30%
and straight-line depreciation is allowed for tax purpose. Calculate the cash flows.
4. XYZ is interested in assessing the cash flows associated with the replacement of an old
machine by a new machine. The old machine bought a few years ago has a book value
of Rs. 90,000and it can be sold for Rs. 90,000. It has a remaining life of five years after
which its salvage value is expected to be nil. It is being depreciated annually at the rate
of 20 per cent (written down value method.) The new machine costs Rs. 4,00,000. It is
expected to fetch Rs. 2,50,000 after five years when it will no longer be required. It will
be depreciated annually at the rate of 33.33 per cent (written down value method.) The
new machine is expected to bring a saving of Rs.1,00,000 in manufacturing costs.
Investment in working capital would remain unaffected. The tax rate applicable to the
firm is 30 per cent. Find out the relevant cash flow for this replacement decision. (Tax
on capital gain/ loss to be ignored).
5. XYZ Ltd. is trying to decide whether it should replace a manually operated machine
with a fully automatic version of the same machine. The existing machine, purchased
ten years ago, has a book value of Rs. 1,40,000 and remaining life of 10 years. Salvage
value is Rs. 40,000. The machine has recently begun causing problems with
breakdowns and is costing the company Rs. 20,000 per year in maintenance expenses.
The company has been offered Rs. 1,00,000 for the old machine as a trade-in on the
automatic model which has a delivery price (before allowance for trade-in) of Rs.
2,20,000. It is expected to have a ten-year life and a salvage value of Rs. 20,000. The
new machine will require installation modifications costing Rs.40,000 to the existing
facilities, but it is estimated to have a cost savings in materials of Rs.80,000 per year.
Maintenance costs are included in the purchase contract and are borne by the machine
manufacturer. The tax rate is 30% (applicable to both revenue income as well as capital
gains/losses). Straight line depreciation over ten years will be used. Find out the
relevant cash flows.
6. ABC & Co. is considering a proposal to replace one of its plants costing Rs. 60,000 and
having a written down value of Rs. 24,000. The remaining economic life of the plant is
4 years after which it will have no salvage value. However, if sold today, it has a salvage
value of Rs. 20,000. The new machine costing Rs. 1,30,000 is also expected to have a
life of 4 years with a scrap value of Rs. 18,000. The new machine, due to its
technological superiority, is expected to contribute additional annual benefit (before
depreciation and tax) of Rs. 60,000. Find out the cash flows associated with this
decision given that the tax rate applicable to the firm is 30%. (The capital gain or loss
may be taken as not subject to tax.)
