Question 3.RQ.35: Royal Industries is considering to buy a moulding machine. T......

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

Royal Industries is considering to buy a moulding machine. The machine (having capital cost of Rs 20 lakh) is expected to have 4 years economic useful life with no salvage value; the company follows the straight line method of depreciation and the same is accepted for tax purposes. The expected CFAT (with corporate tax rate of 35 per cent) during its 4 years economic useful life are as follows:
$\,$ Inflation is expected to be 8 per cent per year and the machine’s cost of capital in real terms would be 10 per cent. Compute the NPV of purchasing this machine.

4	3	2	$Year$ 1
Rs 4 lakh	Rs 7 lakh	Rs 10 lakh	CFAT Rs 8 lakh

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Since the cost of capital is stated in real terms, nominal CFAT need to be converted into real terms by deflating at inflation rate of 8 per cent. Relevant computations related to NPV are shown in Table.

Alternatively, nominal CFAT provided in the question can be discounted by nominal cost of capital (n).
We know (1 + $n$ ) = (1 + $r$ ) (1 + $i$ )
$\,$ $n = r + i + ri$
$\,$ = 0.10 + 0.08 + .008 = 0.188
$\,$ = 18.8 %

$\,$ (a) Based on interpolation as per Table A-3.
$\,$ (b) Difference in net present value computed by two methods (Rs 50,800
$\,$ and Rs 49,677) is due to approximation.
$\,$ In effect, both the methods yield identical results, both in terms of acceptance/rejection decision and in terms of net present value.

Determination\> of\> NVP\> in\> real \>terms

$Total\>PV$	$PV\>factor\>at\>0.10$	$Real\>CFAT$	$Deflated\>factor\>at$ 0.08ª	$CFAT$	$Year$
Rs 6,73,387	0.909	Rs 7,40,800	0.926	Rs 8,00,000	1
7,07,882	0.826	8,57,000	0.857	10,00,000	2
4,17,406	0.751	5,55,800	0.794	7,00,000	3
2,51,002	0.683	3,67,500	0.735	5,00,000	4
20,49,677					Total present value
20,00,000					Less cash outflows
49,677					Net present value

ªAs per Table A-3.

$Total\>PV$	$PV\>factor\>at\>18.8\%^a$	$Nominal\>CFAT$	$Year$
Rs 6,73,600	0.842	Rs 8,00,000	1
7,09,000	0.709	10,00,000	2
4,17,200	0.596	7,00,000	3
2,51,000	0.502	5,00,000	4
20,50,800			Total present value
20,00,000			Less cash outflows
50,800 $^\mathrm{b}$			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