Question 5.S2.EQ.8: A Company is considering a proposal of installing a drying e......
A Company is considering a proposal of installing a drying equipment. The equipment would involve a cash outlay of Rs 6,00,000 and net working capital of Rs 80,000. The expected life of the project is 5 years without any salvage value. Assume that the company is allowed to charge depreciation on straight-line basis for income-tax purpose. The estimated before-tax cashinflows are given below:
The applicable income-tax rate to the Company is 35%. If the Company’s opportunity cost of capital is 12%, calculate the equipment’s discounted payback period, payback period, net present value and internal rate of return.
(CA—May, 2006)
| Before-tax cash-inflows (Rs ’000) | |||||
| Year | 1 | 2 | 3 | 4 | 5 |
| 240 | 275 | 210 | 180 | 160 | |
Determination of cash inflows after taxes (CFAT)
Determination of pay back period, discounted pay back period and net present value (NPV).
(i) Pay back (PB) period: The recovery of investment (Rs 6,80,000) falls between the third and fourth years.
Therefore the PB is 3 years plus a fraction of 4th year. The fractional value is = Rs 82,750/Rs 1,59,000 = 0.52.
Thus, the PB period is 3.52 years.
(ii) Disconnected PB period is 4 years plus a fraction of 5th year. The fractional value is = (Rs 99,032/Rs 1,28,142) = 0.77. Thus, the discounted PB period is 4.77 years.
(iii) Net present value is Rs 29,110.
(iv) Determination of IRR: Since the NPV is positive at 12%, the IRR is likely to be higher. The computation of IRR involves interpolation also. Let us try discount rates of 13% and 14%. Computation of Total PV and NPV at 13% and 14%.
The IRR is between 13% and 14%. By interpolation it is 13% + (Rs 11,962/Rs 16,650) = 0.72 = 13.72%.
| Year | CFBT | Depreciation (Rs 6,00,000/5) |
EBT | Taxes (0.35) |
EAT | CFAT (EAT + D) |
| 1 | Rs 2,40,000 | Rs 1,20,000 | Rs 1,20,000 | Rs 42,000 | Rs 78,000 | Rs 1,98,000 |
| 2 | 2,75,000 | 1,20,000 | 1,55,000 | 54,250 | 1,00,750 | 2,20,750 |
| 3 | 2,10,000 | 1,20,000 | 90,000 | 31,500 | 58,500 | 1,78,500 |
| 4 | 1,80,000 | 1,20,000 | 60,000 | 21,000 | 39,000 | 1,59,000 |
| 5 | 1,60,000 | 1,20,000 | 40,000 | 14,000 | 26,000 | \begin{array}{c} 1,46,000 \\ \\ + 80,000 \end{array} \bigg\} |
| 5 Release of net working capital | ||||||
| Year | CFAT | Cumulative CFAT |
PVIF (0.12) |
Total PV (CFAT × PVIF) |
Cumulative present value |
| 1 | Rs 1,98,000 | Rs 1,98,000 | 0.893 | Rs 1,76,814 | Rs 1,76,814 |
| 2 | 2,20,750 | 4,18,750 | 0.797 | 1,75,938 | 3,52,752 |
| 3 | 1,78,500 | 5,97,250 | 0.712 | 1,27,092 | 4,79,844 |
| 4 | 1,59,000 | 7,56,250 | 0.636 | 1,01,124 | 5,80,968 |
| 5 | 2,26,000 | 9,82,250 | 0.567 | 1,28,142 | 7,09,110 |
| Total present value | 7,09,110 | ||||
| Less cash outflows | 6,80,000 | ||||
| NPV | 29,110 | ||||
| Year | CFAT | PV factor at | Total | PV at | |
| 13% | 14% | 13% | 14% | ||
| 1 | Rs 1,98,000 | 0.885 | 0.877 | Rs 1,75,230 | Rs 1,73,646 |
| 2 | 2,20,750 | 0.783 | 0.769 | 1,72,847 | 1,69,757 |
| 3 | 1,78,500 | 0.693 | 0.675 | 1,23,700 | 1,20,487 |
| 4 | 1,59,000 | 0.613 | 0.592 | 97,467 | 94,128 |
| 5 | 2,26,000 | 0.543 | 0.519 | 1,22,718 | 1,17,294 |
| Total present value | 6,91,962 | 6,75,312 | |||
| Les cash outflows | 6,80,000 | 6,80,000 | |||
| Net present value | 11,962 | (4,688) | |||