Question 5.S2.EQ.2: Acompany proposes to install a machine involving a capital c......
Acompany proposes to install a machine involving a capital cost of Rs 3,60,000. The life of the machine is 5 years and its salvage value at the end of the life is nil. The machine will produce the net operating income after depreciation of Rs 68,000 per annum. The company’s tax rate is 45 per cent.
The net present value factors for 5 years are as under:
You are required to calculate the internal rate of return of the proposal.
(CA—November, 2002)
| Discounting rate (%) | 14 | 15 | 16 | 17 | 18 |
| Cumulative factor | 3.43 | 3.35 | 3.27 | 3.20 | 3.13 |
(i) Determination of CFAT for 5 years (t = 1 – 5)
(ii) Determination of internal rate of return:
(a) Determination of payback period (Rs 3,60,000/1,09,400) = 3.29.
(b) The factors closest to 3.29 are 3.35 at 15 per cent rate of discount and 3.27 at 16 per cent rate of discount. The actual IRR would be between 15 and 16 per cent. Using interpolation the IRR would be 15 per cent + 0.75 i.e., (3.35 – 3.29 = 0.06)/(3.35 – 3.27 = 0.08) = 15.75 per cent
| Net operating income per annum | Rs 68,000 |
| Less taxes (0.45) | 30,600 |
| Earnings after taxes | 37,400 |
| Add depreciation (Rs 3,60,000/5 years) | 72,000 |
| Cash inflows after taxes (CFAT) | 1,09,400 |