# Question 3.PP.29: Assume everything to be the same as contained in P3.28, exce......

Assume everything to be the same as contained in P3.28, except that the firm follows written down value method of depreciation at the rate of 25 per cent. Assume further that the company does not have any other asset in the block of 25 per cent and the machine is expected to have salvage value of Rs 5 lakh at year-end 5. Does your answer change? You are to compute NPV in real terms.

Step-by-Step
The 'Blue Check Mark' means that this solution was answered by an expert.

There will be a change in PV of tax savings due to depreciation in view of change in the method of depreciation; there will be tax savings due to short-term capital loss at year-end 5 also.
Recommendation: Since NPV is positive, the firm should accept the project. The answer regarding acceptance of the project remains unchanged.

$Tax \>savings\> (CFAT)\> in \>nominal \>and \>real\> terms\> due \>to\> depreciation$
 $CFAT,\>Real$ $Discount\>factor$ $at \>0.06$ $Tax\>savings/Nominal$ $CFAT,\> (Depreciation × 0.35)$ $Depreciation$ $Year$ Rs 4,12,562 0.943 Rs 4,37,500 Rs 12,50,000 1 2,92,031 0.890 3,28,125 9,37,500 2 2,06,719 0.840 2,46,094 7,03,125 3 1,46,179 0.792 1,84,570 5,27,344 4*

* Since the block ceases to exist in the 5th year, no depreciation is charged in year 5.
$Present\> value \>of\>tax \>shield,\> salvage \>value\> and\> short-term \>capital\> loss$

 $Total\>PV$ $PV\>factor\>0.10$ $Real\>CFAT$ $Year$ Rs 3,75,019 0.909 Rs 4,12,562 1 2,41,218 0.826 2,92,031 2 1,55,246 0.751 2,06,719 3 99,840 0.683 4                                                                                                                                                                                         1,46,179 8,71,323 (i) $Present\>value\> of\> tax\> shield\> due\> to\> depreciation$ Salvage value (at year-end 5) Rs 5,00,000 Salvage value (×) 0.747 (X) Deflated/discount factor at 0.06 (at year-end 5) 3,73,500 Real Cash inflows (×) 0.621 (X) Discount factor (at year-end 5) at 0.10 2,31,943 (ii) $Present\>value \>of \>salvage\> value$ Short-term capital loss (at year-end 5) 50,00,000 Cost of machine 34,17,969 Less accumulated depreciation in 4 years 15,82,031 Book value of machine in year 5 50,00,000 Less sale value 10,82,031 Short-term capital loss (STCL) 3,78,711 Tax savings (Rs 10,82,031 × 0.35) on STCL/CFAT, nominal (×) 0.747 (X) Deflation factor at 0.06 (at year-end 5) 2,82,897 Real CFAT (×) 0.621 (X) Discount factor (at year-end 5) at 0.10 1,75,679 (iii) $Present\>value\>of\>STCL$ 12,78,945 Total present value (Rs 8,71,323 + Rs 2,31,943 + Rs 1,75,679)
$NPV\> of \>machine$
 Rs 49,28,300 Present value of operating CFAT 4,63,887 Present value of release of working capital 12,78,945 Present value of tax shield due to depreciation, salvage value and short-term capital loss 66,71,132 Total present value 60,00,000 Less present value of cash outflows 6,71,132 Net present value

Question: 3.17

## From the undermentioned facts, compute the net present values (NPVs) of the two projects for each of the possible cash flows, using sensitivity analysis. ...

The NPV of each project, assuming a 10 per cent re...
Question: 3.14

## Sound Limited has a financial resource constraint of a maximum sum of Rs 65 lakh in the current year. It has evaluated a large number of investment projects but has discarded all except those listed below. All the listed investment proposals are independent. The selected list of investments provide ...

First, we should arrange the investment projects i...
Question: 3.13 (Indivisible Project)

## A company working against a self-imposed capital budgeting constraint of Rs 70 crore is trying to decide which of the following investment proposals should be undertaken by it. All these investment proposals are indivisible as well as independent. The list of investments along with the investment ...

NPV from investments D, E and B is Rs 68 crore wit...
Question: 3.15

## Proposal X requires an initial capital outlay of Rs 2,00,000, with no salvage value, and will be depreciated on a straight line basis for tax purposes. The earnings before depreciation and taxes (EBDT) during its 5 year life are: ...

$\,$  Since the net present value is ...
Question: 3.RQ.32

## XYZ Ltd wants to purchase a plant for its expanding operations. The desired plant is available at Rs 10 lakh. The expected earnings before depreciation and taxes (EBDT) during its 5 years economic useful life are as follows: ...

Recommendation: Since NPV is positive, the company...
Question: 3.PP.26

## A new machine is expected to generate the following set of incremental CFAT during its 5 year economic useful life: The rate of inflation during the period is expected to be 8 per cent and the project’s cost of capital in real terms would be 10 per cent. Should the machine be purchased if it costs ...

Recommendation: The machine should be purchased as...
Question: 3.23

## Assume that a project has a mean of Rs 40 and standard deviation of Rs 20. The management wants to determine the probability of the NPV under the following ranges: (i) Zero or less, (ii) Greater than zero, (iii) Between the range of Rs 25 and Rs 45, (iv) Between the range of Rs 15 and Rs 30. ...

(i) Zero or less: The first step is to determine t...
Question: 3.RQ.36

## ABC Ltd is considering a proposal to buy a machine for Rs 30,000. The expected cash flows after taxes from the machine for a period of 3 consecutive years are Rs 20,000 each. After the expiry of the useful life of the machine, the seller has guaranteed its repurchase at Rs 2,000. The firm’s ...

Recommendation: Yes, the company should accept the...
Question: 3.RQ.35

## 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 ...

Determination of real discount rate \,[/lat...