Question 3.RQ.34: Strong Company wants to launch a new product, suggested by i......

Management Accounting and Financial Analysis for CA Final Examination [995093]

Strong Company wants to launch a new product, suggested by its marketing department. For this purpose a new machine is to be purchased. The relevant data processed in this regard is as follows:
$\,$ The company uses 13 per cent as required cost of capital (nominal) to evaluate new projects. The rate of inflation during the period is expected to be 6 per cent. Determine NPV of the machine using both the nominal as well as real rate of discount, and comment on the results.

Rs 20,00,000	Cost of new machine
6,00,000	CFAT: year 1
7,00,000	2
8,00,000	3
5,00,000	4
4,00,000	5

Step-by-Step

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Determination of real discount rate
$\,$ $r$ = (1 + $n$ )/ (1 + $i$ ) – 1
$\,$ = (1.13/1.06) – 1 = 1.066 – 1= 0.066 or 6.6%

$\,$ Both the methods give identical results. The project is acceptable as NPV is positive. (The minor difference in the NPV under the two methods is on account of rounding off the values).

NPV \>using\> nominal\> rate \>of \>discount

$Total\>PV$	$PV\>factor\>at\>0.13$	$CFAT$	$Year$
Rs 5,31,000	0.885	6,00,000	1
5,48,100	0.783	7,00,000	2
5,54,400	0.693	8,00,000	3
3,06,500	0.613	5,00,000	4
2,17,200	0.543	4,00,000	5
21,57,200			Total present value
20,00,000			Less cost of new machine
1,57,200			Net present value

NPV\> using \>real \>rate \>of \>discount

$Total\>PV$ $\,$	$PV\>factor\>at\>6.6\%$ $\,$	$Real\>CFAT$ $\,$	$Deflated\>factor\>at$ $0.06\>as\>per\>Table\>A-3$	$CFAT$ $\,$	$Year$ $\,$
Rs 5,30,720	0.938	Rs 5,65,800	0.943	6,00,000	1
5,48,240	0.880	6,23,000	0.890	7,00,000	2
5,54,400	0.825	6,72,000	0.840	8,00,000	3
3,06,504	0.774	3,96,000	0.792	5,00,000	4
2,17,228	0.727	2,98,800	0.747	4,00,000	5
21,57,092					Total present value
20,00,000					Less cost of new machine
1,57,092					Net present value

Table A-3 The Present Value of One Rupee

$10\%$	$9\%$	$8\%$	$7\%$	$6\%$	$5\%$	$4\%$	$3\%$	$2\%$	$1\%$	$Year$
.909	.917	.926	.935	.943	.952	.962	.971	.980	0.990	1
.826	.842	.857	.873	.890	.907	.925	.943	.961	0.980	2
.751	.772	.794	.816	.840	.864	.889	.915	.942	.971	3
.683	.708	.735	.763	.792	.823	.855	.888	.924	.961	4
.621	.650	.681	.713	.747	.784	.822	.863	.906	.951	5
.564	.596	.630	.666	.705	.764	.790	.837	.888	.942	6
.513	.547	.583	.623	.665	.711	.760	.813	.871	.933	7
.467	.502	.540	.582	.627	.677	.731	.789	.853	.923	8
.424	.460	.500	.544	.592	.645	.703	.766	.837	.914	9
.386	.422	.463	.508	.558	.614	.676	.744	.820	.905	10
.350	.388	.429	.475	.527	.585	.650	.722	.804	.896	11
.319	.356	.397	.444	.497	.575	.625	.701	.789	.887	12
.290	.326	.368	.415	.469	.530	.601	.681	.773	.879	13
.263	.299	.340	.388	.442	.505	.577	.661	.758	.870	14
.239	.275	.315	.362	.417	.481	.555	.642	.743	.861	15
.218	.252	.292	.339	.394	.458	.534	.623	.728	.853	16
.198	.231	.270	.317	.371	.436	.513	.605	.714	.844	17
.180	.212	.250	.296	.350	.416	.494	.587	.700	.836	18
.164	.194	.232	.227	.331	.396	.475	.570	.686	.828	19
.149	.178	.215	.258	.312	.377	.456	.554	.673	.820	20
.135	.164	.199	.242	.294	.359	.439	.538	.660	.811	12
.123	.150	.184	.226	.278	.342	.422	.522	.647	.803	22
.112	.138	.170	.211	.262	.326	.406	.507	.634	.795	23
.102	.126	.158	.197	.247	.310	.390	.492	.622	.788	24
.092	.116	.146	.184	.233	.295	.375	.478	.610	.780	25
.057	.075	.099	.131	174	.231	.308	.412	.552	.742	30
.036	.049	.068	.094	.130	.181	.253	.355	.500	.706	35
.022	.032	.046	.067	.097	.142	.208	.307	.453	.672	40
.014	.021	.031	.048	.073	.111	.171	.264	.410	.639	45
.009	.013	.021	.034	.054	.087	.141	.228	.372	.608	50

(Contd.)

$20\%$	$19\%$	$18\%$	$17\%$	$16\%$	$15\%$	$14\%$	$13\%$	$12\%$	$11\%$	$Year$
.833	.840	.847	.855	.862	.870	.877	.885	.893	.901	1
.694	.706	.718	.731	.743	.756	.769	.783	.797	.812	2
.579	.593	.609	.624	.641	.658	.675	.693	.712	.731	3
.482	.499	.516	.534	.552	.572	.592	.613	.636	.659	4
.402	.419	.437	.456	.476	.497	.519	.543	.567	.593	5
.335	.352	.370	.390	.410	.432	.456	.480	.507	.535	6
.279	.296	.314	.333	.354	.376	.400	.425	.452	.482	7
.233	.249	.266	.285	.305	.327	.351	.376	.404	.434	8
.194	.209	.225	.243	.263	.284	.308	.333	.361	.391	9
.162	.176	.191	.208	.227	.274	.270	.295	.322	.352	10
.135	.184	.162	.178	.195	.215	.237	.261	.287	.317	11
.112	.124	.137	.152	.168	.187	.208	.231	.257	.286	12
.093	.104	.116	.130	.145	.163	.182	.204	.229	.258	13
.078	.088	.099	.111	.125	.141	.160	.181	.205	.232	14
.065	.074	.084	.095	.108	.123	.140	.160	.183	.209	15
.054	.062	.071	.081	.093	.107	.123	.141	.163	.188	16
.045	.052	.060	.069	.080	.093	.108	.125	.146	.170	17
.038	.044	.051	.059	.069	.081	.095	.111	.130	.153	18
.031	.037	.043	.051	.060	.070	.083	.098	.116	.138	19
.026	.031	.037	.043	.051	.061	.073	.087	.104	.124	20
.022	.026	.031	.037	.044	.053	.064	.077	.093	.112	21
.018	.022	.026	.032	.038	.046	.056	.068	.083	.101	22
.015	.018	.022	.027	.033	.040	.049	.060	.074	.091	23
.013	.015	.019	.023	.028	.035	.043	.053	.066	.082	24
.010	.013	.016	.020	.024	.030	.038	.047	.059	.074	25
.004	.005	.007	.009	.012	.015	.020	.026	.033	.044	30
.002	.002	.003	.004	.006	.008	.010	.014	.019	.026	35
.001	.001	.001	.002	.003	.004	.005	.008	.011	.015	40
.000	.000	.001	.001	.001	.002	.003	.004	.006	.009	45
.000	.000	.000	.001	.001	.001	.001	.002	.003	.005	50

(Contd.)

$30\%$	$29\%$	$28\%$	$27\%$	$26\%$	$25\%$	$24\%$	$23\%$	$22\%$	$21\%$	$Year$
.769	.775	.781	.787	.794	.800	.806	.813	.820	.826	1
.592	.601	.610	.620	.630	.640	.650	.661	.672	.683	2
.455	.466	.477	.488	.500	.512	.524	.537	.551	.564	3
.350	.361	.373	.384	.397	.410	.423	.437	.451	.467	4
.269	.280	.291	.303	.315	.328	.341	.355	.370	.386	5
.207	.217	.227	.238	.250	.262	.275	.289	.303	.319	6
.159	.168	.178	.188	.198	.210	.222	.235	.249	.263	7
.123	.130	.139	.148	.157	.168	.179	.191	.204	.218	8
.094	.101	.108	.116	.125	.134	.144	.155	.167	.180	9
.073	.078	.085	.092	.099	.107	.116	.126	.137	.149	10
.056	.061	.066	.072	.079	.086	.094	.103	.112	.123	11
.043	.047	.052	.057	.062	.069	.076	.083	.092	.102	12
.033	.037	.040	.045	.050	.055	.061	.068	.075	.084	13
.025	.028	.032	.035	.039	.044	.049	.055	.062	.069	14
.020	.022	.025	.028	.031	.035	.040	.045	.051	.057	15
.015	.017	.019	.022	.025	.028	.032	.036	.042	.047	16
.012	.013	.015	.017	.020	.023	.026	.030	.034	.039	17
.009	.010	.012	.014	.016	.018	.021	.024	.028	.032	18
.007	.008	.009	.011	.012	.014	.017	.020	.023	.027	19
.005	.006	.007	.008	.010	.012	.014	.016	.019	.022	20
.004	.005	.006	.007	.008	.009	.011	.013	.015	.018	21
.003	.004	.004	.005	.006	.007	.009	.011	.013	.015	22
.002	.003	.003	.004	.005	.006	.007	.009	.010	.012	23
.002	.002	.003	.003	.004	.005	.006	.007	.008	.010	24
.001	.002	.002	.003	.003	.004	.005	.006	.007	.009	25
.000	.000	.001	.001	.001	.001	.002	.002	.003	.003	30
.000	.000	.000	.000	.000	.000	.001	.001	.001	.001	35
.000	.000	.000	.000	.000	.000	.000	.000	.000	.000	40
.000	.000	.000	.000	.000	.000	.000	.000	.000	.000	45
.000	.000	.000	.000	.000	.000	.000	.000	.000	.000	50