Capital Budgeting 1. A company is considering an investment proposal to install new milling controls at a cost of Rs. 50,000. The facility has a life expectancy of 5 years and no salvage value. The tax rate is 35%. Assume the firm uses straightline depreciation and the same is allowed for tax purposes. The estimated cash flows !efore depreciation and tax from the investment proposal are as follows " #ear #ear $ash flow !efore depreciation and tax Rs. 0,000 & Rs. 0,'(& 3 Rs. &,)'( * Rs. 3,*'& 5 Rs. &0,3+5 $ompute the following " i- ay !ac/ period ii- Average Average rate of return iii- 1nternal rate of return iv- 2et present value at 0% discount rate v- rofita!ility index at 0% discount rate 2. and ox is considering the purchase of a new wash and dry e4uipment in order to expand its operations. Two types of options are availa!le a lowspeed system 677- with an initial cost of Rs. &0,000 and a highspeed system 877- with an initial cost of Rs. 30,000. 9ach system has a life of fifteen years and no salvage value. The net cash flows after taxes associated with each investment proposal are " Rs. *,000 p.a. for 677 and Rs. ',000 p.a. for 877. :hich speed system should !e chosen chosen !y and ox assuming assuming *% cost of capital; capital; 3. 8onda
etails of profita!ility pro=ections for the next * years are as follows "
articulars articular s 7ales 6ess ?aria!le ?aria!le cost @ixed cost allocated>epreciation 2et rofitloss-
#ear #ear 50.00 &).00 +.00 '.00 .00-
& *5.00 &*.50 ).50 '.00 3.00-
3 *0.00 &3.00 '.50 0.50
* 35.00 +.00 '.00 .00
in Rs. 6a/hs-
As the estimated wor/ing results are not very good and as the company has got a very good offer for the machine, the <> feels that the machine should !e sold immediately. :hat is your advice to the <>; $ost of capital for the company is 5%-. 4. B#C 6td. 6td. manuf manufac actur tures es comp compone onents nts for car car indust industry ry.. 1t is consi conside derin ring g autom automati ating ng its line line for producing cran/shaft cran/shaft !earing. The The automated automated e4uipment will cost Rs. Rs. )5 la/hs. 1t will replace replace e4uipment e4uipment with a residual value of Rs. + la/hs and a written down !oo/ value of Rs. &0 la/hs. 1t is anticipated that the existing machine has a further five years to run, after which its scrap value would !e Rs. 50,000. At present, the line has a capacity of &.5 la/h units per annum !ut it has !een running at +0% of capacity !ecause of lac/ of demand for its output. The new line will have a capacity of * la/h units per annum. 1ts life is expected to !e 5 years after which scrap value will !e Rs. 0,50,000. The main !enefit of the new proposal will !e reduction in staffing level and an improvement improvement in price due to its superior 4uality. 4uality.
The accountant has prepared the cost estimates shown !elow !ased on output of 0 la/h units per annum. @ixed overheads include depreciation on the old machine of Rs. * la/hs per annum and Rs. 3
la/hs for the new machine. 1t is considered that for the company overall other fixed overheads are unli/ely to change. articulars Dld 6ine 2ew 6ine 7elling rice Rs. 5.00 Rs. 5.50
The advanced model will cost Rs. &,35,000 with a life of + years and a scrap value of Rs. &,05,000. A comparison !etween the two is as follows " articulars 9xisting machine Advanced model $apacity per annum &,00,000 units &,30,000 units 7elling price per unit Rs. (.50 Rs. (.50
The 8udson sells for Rs. )5 each regardless of the production method employed. The scrap value of the automated production line, in five years time, will !e Rs. 00,000, whilst the partial automated line will have a nil residual value. The management uses straightline depreciation and the re4uired rate of return on capital investment is '% per annum. >epreciation is considered to !e the only incremental fixed cost. 1n analysing investment opportunities of this type, the company calculates the average total cost per unit, annual profit, the !rea/even volume per year and the 2?.
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a- >iscuss the figures which would !e circulated to the management of B#C $o. 6td., in order to assist their investment analysis. !- $omment on the figures produced and ma/e a recommendation, discussing any reservations you consider to !e appropriate. 7. Avon $hemical $ompany 6imited is presently paying an outside firm Re. per gallon to dispose the waste material resulting from its manufacturing operations. At normal operating capacity, the waste is a!out *0,000 gallons per year. After spending Rs. *0,000 on research, the company discovered that the waste could !e sold for Rs. 5 per gallon if it was processed further. Additional processing would, however, re4uire an investment of Rs. ',00,000 in new e4uipment, which would have an estimated life of 5 years and no salvage value. >epreciation would !e computed !y :>? method G &5%. There are no other assets in the &5% !loc/.
9xcept for the cost incurred in advertising Rs. &0,000 per year, no change in the present administrative and selling expenses is expected if the new product is sold. The details of additional processing costs are as follows ?aria!le " Rs. 5 per gallon of waste put into process @ixed excluding depreciation- " Rs. 30,000 per year. 1n costing the new product, general factory overheads will !e allocated G Re. per gallon. There will !e no losses in processing and it has !een assumed that all the waste processed in a given year will !e sold in that very year. Hnprocessed waste will !e sold off as per present policy. 9stimates indicate that 30,000 gallons of the new product could !e sold each year. The management see/s your advice in deciding whether to dispose off the waste or process it further. :hich alternative would you recommend; Assume that the firmEs cost of capital is 5% and the tax rate applica!le to it is 35%.-
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