A company is considering the proposal of taking up a new project which requires an invetment of Rs 400 lakh on machinery and other assets. The project is expected to yield the following earnings (before depreciation and taxes) over the next five years:
The cost of raising the additional capital is 12% and assets have to be depreciated at 20% on ‘Written Down Value’ basis. The scrap value at the end of the five years’ period may be taken as zero. Income-tax applicable to the company is 50%.
You are required to calculate the net present value of the project and advise the management to take appropriate decision.
(CA(PE-II)—May, 2007)
Year | Earnings (Rs in lakh) |
1 | 160 |
2 | 160 |
3 | 180 |
4 | 180 |
5 | 150 |
Determination of net present value (NPV) of new project (Rs in lakh)
(b) Net present value
Advise: The company is advised to take-up the new project as the NPV is positive.
(I) Cash outflows: | |
Investment/Cost of machinery and other assets | Rs 400.00 |
(II) (a) CFAT |
Year | EBDT | Depreciation (D) (20% of WDV) |
EBT | EAT (EBT × 0.5) | CFAT (EAT + D) |
1 | Rs 160 | Rs 80.00 | Rs 80 | Rs 40 | Rs 120 |
2 | 160 | 64.00 | 96 | 48 | 112 |
3 | 180 | 51.20 | 128.8 | 64.4 | 115.6 |
4 | 180 | 40.96 | 139.04 | 69.52 | 110.48 |
5 | 150 | \begin{array}{c} 32.77 \\ \\ \\ 131.07 \end{array} \bigg\} | |||
5 Loss on disposal of assets* | (13.84) | (6.92) | 156.92 |
*alternatively, Rs 163.84 can be shown as short-term capital loss (assuming block of assets ceases to exist).
Year | CFAT | PV factor (0.12) | Total PV |
1 | Rs 120 | 0.893 | Rs 107.16 |
2 | 112 | 0.797 | 89.26 |
3 | 115.6 | 0.712 | 82.31 |
4 | 110.48 | 0.636 | 70.27 |
5 | 156.92 | 0.567 | 88.97 |
Total present value | 437.97 | ||
Less cash outflows | 400.00 | ||
Net present value | 37.97 |