{"id":16401,"date":"2023-03-15T17:03:53","date_gmt":"2023-03-15T11:33:53","guid":{"rendered":"https:\/\/gstguntur.com\/?p=16401"},"modified":"2023-03-15T17:05:15","modified_gmt":"2023-03-15T11:35:15","slug":"investment-decisions-ca-inter-fm-study-material","status":"publish","type":"post","link":"https:\/\/gstguntur.com\/investment-decisions-ca-inter-fm-study-material\/","title":{"rendered":"Investment Decisions \u2013 CA Inter FM Study Material"},"content":{"rendered":"

Investment Decisions \u2013 CA Inter FM Study Material<\/a> is designed strictly as per the latest syllabus and exam pattern.<\/p>\n

Investment Decisions \u2013 CA Inter FM Study Material<\/h2>\n

Theory Questions<\/strong><\/p>\n

Question 1.
\nDistinguish between Net Present Value method and Internal Rate of Return method. (4 Marks Nov. 2011, Nov. 2015)
\nAnswer:
\nNPV: NPV or net present value refers to the net balance after subtracting present value of outflows from the present value of inflows. Present value is calculated by using cost of capital as discount rate.<\/p>\n

As per NPV technique internal cash inflows are re-invested at cost of capital rate. NPV higher than zero indicates that project will provide return higher than cost of capital, zero NPV indicates that expected cash inflow will provide return equal to cost of capital and negative NPV indicates that project will fail to recover even cost of funds to be invested in proposal. Negative NPV leads to rejection of proposal. NPV is expressed in financial values and fails to provide actual rate of return associated with proposal.<\/p>\n

IRR : IRR technique refers to actual rate of return associated with proposal. IRR refers to rate of discount at which present value of inflows and outflows are same or NPV is zero.<\/p>\n

IRR is expressed in percentage terms. As per IRR technique internal cash inflows are re-invested at IRR rate. IRR rate is compared with desired rate of return. Proposal is accepted when IRR is higher than desired rate of return and rejected when it is lower than desired rate of return.<\/p>\n

There may be contradictory results under NPV and IRR techniques in some situations due to size disparity problem, time disparity problem and unequal expected lives.<\/p>\n

Question 2.
\nWhat is ‘Internal Rate of Return\u2019? Explain. (4 Marks Nov. 2014, 2 Marks Jan. 2021)
\nAnswer:
\nIRR technique refers to actual rate of return associated with proposal. IRR refers to rate of discount at which present value of inflows and outflows are same or NPV is zero. IRR is expressed in percentage terms. As per IRR technique internal cash inflows are re-invested at IRR rate.<\/p>\n

IRR rate is com-pared with desired rate of return. Proposal is accepted when IRR is higher than desired rate of return and rejected when it is lower than desired rate of return.<\/p>\n

\"Investment<\/p>\n

Question 3.
\nWhich method of comparing a number of Investment proposals is most suited if each proposal involves different amount of cash inflows? Explain and state its limitations. (4 Marks Nov. 2017)
\nAnswer:
\nThe best technique to compare number of investment proposals involves different amount of cash inflows is Profitability Index or Desirability Factor. In this technique present value of cash inflows is compared with present value of outflow and project is accepted if PI is 1 or above. It is calculated as :
\nDesirability Factor or Profitability index \\(=\\frac{\\text { PV of Inflows }}{\\text { PV of Outflows }}\\)<\/p>\n

Limitations of Profitability Index:<\/p>\n

    \n
  1. This technique cannot be used in case of capital rationing with indivisible projects.<\/li>\n
  2. Many times single large project with high NPV is selected and ignored various small projects with higher cumulative NPV than selected single one.<\/li>\n
  3. There is a situation where a project with a lower profitability index may generate cash flows in such a way that another project can be also taken after one or two years later, the total NPV in such case will be higher than NPV of another project with highest Profitability Index today.<\/li>\n<\/ol>\n

    Question 4.
    \nExplain the steps while using the equivalent annualized criterion. (3 Marks Nor. 2019)
    \nAnswer:
    \nFollowing are the steps involved in Equivalent Annualised Criterion :<\/p>\n

    Step 1 : Calculate NPV of the projects or PV of outflow of the projects.<\/p>\n

    Step 2 : Calculate Equivalent Annualized NPV or Outflow :
    \nEquivalent Annualised NPV or Outflow \\(=\\frac{\\text { NPV or PV of Outflow }}{\\text { PVIFA }}\\)<\/p>\n

    Step 3: Select the proposal having higher annualised NPV or Lower annualised outflow.<\/p>\n

    Practical Problems<\/strong><\/p>\n

    Net Present Value<\/strong><\/p>\n

    Question 1.
    \nDomestic services (P) Ltd. is in the business of providing cleaning sewerage line services at homes. There is a proposal before the company to purchase a mechanised sewerage cleaning system for a sum of \u20b9 20 lakhs. The present system of the company is to use manual labour for the job.
    \nYou are provided with the following information :<\/p>\n

    Proposed Machanised System :<\/p>\n

    Cost of machine : \u20b9 20 lakhs
    \nLife of machine : 10 years
    \nDepreciation (on straight line basis) : 10%
    \nCash Operating cost of machanised system : \u20b9 5 lakhs per annum
    \nPresent System (manual):
    \nManual labour : 200 persons
    \nCost of manual labour : \u20b9 10,000 per person per annum
    \nThe company has after tax cost of fund at tax rate is 30%.
    \nPV factor for 10 years at 10% are as given below :<\/p>\n\n\n\n\n
    Years<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n6<\/td>\n7<\/td>\n8<\/td>\n9<\/td>\n10<\/td>\n<\/tr>\n
    PV factor<\/td>\n0.909<\/td>\n0.826<\/td>\n0.751<\/td>\n0.683<\/td>\n0.621<\/td>\n0.564<\/td>\n0.513<\/td>\n0.467<\/td>\n0.424<\/td>\n0.386<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    You are required to find out whether it is advisable to purchase the machine. Give your recommendation with workings. (8 Marks June 2015)
    \nAnswer:
    \nNet Present Value<\/p>\n\n\n\n\n\n\n
    Year<\/td>\nParticulars<\/td>\n\u20b9<\/td>\nDF @ 10%<\/td>\nPV<\/td>\n<\/tr>\n
    0<\/td>\nCost of Machine<\/td>\n(20,00,000)<\/td>\n1.000<\/td>\n(20,00,000)<\/td>\n<\/tr>\n
    1 – 10<\/td>\nIncremental CFAT<\/td>\n11,10,000<\/td>\n6.144<\/td>\n68,19,840<\/td>\n<\/tr>\n
    NPV<\/td>\n48,19,840<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Recommendation : Company should purchase the machine having positive NPV.<\/p>\n

    Working Notes:<\/strong><\/p>\n

    Calculation of Incremental CFAT:
    \n\"Investment<\/p>\n

    \"Investment<\/p>\n

    Question 2.
    \nPD Ltd. an existing company is planning to introduce a new product with projected life of 8 years. Project cost will be \u20b9 2,40,00,000. At the end of 8 years no residual value will be realized. Working capital of \u20b9 30,00,000 will be needed. The 100% capacity of the project is 2,00,000 units p.a. but the production and sales volume are expected as under :
    \n\"Investment<\/p>\n

    Other information :<\/p>\n

    1. Selling price per unit \u20b9 200.
    \n2. Variable cost is 40% of sales.
    \n3. Fixed cost p.a. \u20b9 30,00,000.
    \n4. In addition to these advertisement expenditure will have to be incurred as under:<\/p>\n\n\n\n\n\n\n\n
    Year<\/td>\n(\u20b9 in Lacs)<\/td>\n<\/tr>\n
    1<\/td>\n50<\/td>\n<\/tr>\n
    2<\/td>\n25<\/td>\n<\/tr>\n
    3-5<\/td>\n10<\/td>\n<\/tr>\n
    6-8<\/td>\n5<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    5. Income tax is 25%.
    \n6. Straight line method of depreciation is permissible for tax purpose.
    \n7. Cost of capital is 10%.
    \n8. Assume that loss cannot be carried forward.
    \nPresent value table<\/p>\n\n\n\n\n
    Year<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n6<\/td>\n7<\/td>\n8<\/td>\n<\/tr>\n
    PVF@10%<\/td>\n0.909<\/td>\n0.826<\/td>\n0.751<\/td>\n0.683<\/td>\n0.621<\/td>\n0.564<\/td>\n0.513<\/td>\n0.467<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Advise about the project acceptability. (10 Marks Nov. 2018)<\/p>\n

    Answer:<\/p>\n

    Net Present Value
    \n\"Investment
    \nCompany should accept the proposal having positive NPV of the project.<\/p>\n

    Working Notes:<\/strong><\/p>\n

    1. Depreciation \\(=\\frac{\\text { Original Cost less Salvage }}{\\text { Life of Equipment }}\\) \\(=\\frac{2,40,00,000}{8 \\text { Years }}\\) = 30,00,000
    \n2. Statement showing CFAT :
    \n\"Investment
    \n\"Investment<\/p>\n

    Question 3.
    \nCK Ltd. is planning to buy a new machine. Details of which are as follows:<\/p>\n

    Cost of the machine at the commencement : \u20b9 2,50,000
    \nEconomic life of the machine : 8 years
    \nResidual value : Nil
    \nAnnual production capacity of the machine : 1,00,000 units
    \nEstimated selling price per unit : \u20b9 6
    \nEstimated variable cost per unit : \u20b9 3
    \nEstimated annual fixed cost(Excluding depreciation) : \u20b9 1,00,000
    \nAdvertisement expenses in 1 st year in addition of fixed cost : \u20b9 20,000
    \nMaintenance expenses in 5th year in addition of fixed cost : \u20b9 30,000
    \nCost of capital\u00a0 : 12%
    \nIgnore tax.<\/p>\n

    Analyse the above mentioned proposal using the Net Present Value method and advice.
    \nNote: The PV factors at 12% are<\/p>\n\n\n\n\n
    Year<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n6<\/td>\n7<\/td>\n8<\/td>\n<\/tr>\n
    PV Factor<\/td>\n.893<\/td>\n.797<\/td>\n.712<\/td>\n.636<\/td>\n.567<\/td>\n.507<\/td>\n.452<\/td>\n.404<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    (5 Marks Nov. 2020)
    \nAnswer:
    \nStatement of NPV
    \n\"Investment<\/p>\n

    Working Note:<\/strong><\/p>\n

    Calculation of Annual Cash Inflow
    \n\"Investment
    \nAdvise : CK limited should buy machine having positive NPV.<\/p>\n

    Various Techniques<\/strong><\/p>\n

    Question 4.
    \nA Ltd. Is considering the purchase of a machine which will perform some operations which are at present preformed by workers. Machines X and Y are alternative models. The following details are available :<\/p>\n\n\n\n\n\n\n\n\n\n\n
    Particulars<\/td>\nMachine X<\/td>\nMachine Y<\/td>\n<\/tr>\n
    Cost of machine<\/td>\n\u20b9 1,50,000<\/td>\n\u20b9 2,40,000<\/td>\n<\/tr>\n
    Estimated life of machine<\/td>\n5 years<\/td>\n6 years<\/td>\n<\/tr>\n
    Estimated cost of maintenance per annum<\/td>\n\u20b9 7,000<\/td>\n\u20b9 11,000<\/td>\n<\/tr>\n
    Estimated cost of indirect materials per annum<\/td>\n\u20b9 6,000<\/td>\n\u20b9 8,000<\/td>\n<\/tr>\n
    Estimated savings in scrap per annum<\/td>\n\u20b9 10,000<\/td>\n\u20b9 15,000<\/td>\n<\/tr>\n
    Estimated cost of supervision per annum<\/td>\n\u20b9 12,000<\/td>\n\u20b9 16,000<\/td>\n<\/tr>\n
    Estimated saving in wages per annum<\/td>\n\u20b9 90,000<\/td>\n\u20b9 1,20,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Depreciation will be charged on straight line basis. The tax rate is 30%. Evaluate the alternation according to :<\/p>\n

    (a) Average rate of return method, and
    \n(b) Present value index method assuming cost of capital being 10%.
    \n(The present value of \u20b9 1.00 @ p.a. for 5 years is 3.79 and for 6 years is 4.354) (8 marks Nov. 2011)<\/p>\n

    Answer:<\/p>\n

    (a) Statement Showing Evaluation of Two Machines (ARR)
    \n\"Investment<\/p>\n

    (b) Statement Showing Evaluation of Two Machines (PI)
    \n\"Investment
    \n\"Investment<\/p>\n

    \"Investment<\/p>\n

    Question 5.
    \nSS limited is considering the purchase of a new automatic machine which will carry out some operations which are at present performed by manual labour. NM-A1<\/sub> and NM-A2<\/sub> two alternative models are available in the market.
    \nThe following details are collected:
    \n\"Investment
    \nDepreciation will be charged on a straight line method. Corporate tax rate is 30 per cent and expected rate of return may be 12 per cent.<\/p>\n

    You are required to evaluate the alternatives by calculating the :<\/p>\n

    (1) Pay- back Period.
    \n(2) Accounting (Average) Rate of Return and
    \n(3) Profitability Index or P.V. Index (P.V. factor for \u20b9 1 @ 12% 0.893; 0.797; 0.712; 0.636; 0.567) (10 Marks Nov. 2012)<\/p>\n

    Answer:<\/p>\n

    Statement of Evaluation
    \n\"Investment
    \n\"Investment
    \nWorking Note:<\/strong>
    \nCalculation of Profit After Tax & CFAT:
    \n\"Investment<\/p>\n

    Question 6.
    \nFH Hospital is considering to purchase a CT. Scan machine. Presently the hospital is outsourcing the CT-Scan Machine and is earning commission of 15,000 per month (net of tax). The following details are given regarding the machine:<\/p>\n

    Cost of CT-Scan machine : \u20b9 15,00,000
    \nOperating cost per annum (excluding depreciation) : \u20b9 2,25000
    \nExpected revenue per annum : \u20b9 7,90,000
    \nSalvage value of machine (after 5 years) : \u20b9 3,00,000
    \nExpected life of machine : 5 years<\/p>\n

    Assuming tax rate @ 30%, whether it would be profitable for the hospital to purchase the machine?<\/p>\n

    Give your recommendation under:<\/p>\n

    (i) Net Present Value Method, and
    \n(ii) Profitability Index Method.<\/p>\n

    PV factors at 12% are given below:<\/p>\n\n\n\n\n
    Year<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n<\/tr>\n
    PV factor<\/td>\n0.893<\/td>\n0.797<\/td>\n0.712<\/td>\n0.636<\/td>\n0.567<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Answer:
    \n(i) Net Present Value
    \n\"Investment
    \nRecommendation: CT-Scan machine should not be purchased having negative NPV.<\/p>\n

    (ii) Profitability Index \\(=\\frac{\\text { PV of Inflows }}{\\text { PV of Outflows }}\\) \\(=\\frac{12,06,538}{15,00,000}\\) = 0.804<\/p>\n

    Recommendation : Since PI is less than 1, CT-Scan machine should not be purchased.<\/p>\n

    Working Notes:<\/strong><\/p>\n

    Calculation of Incremental CFAT:
    \n\"Investment<\/p>\n

    Question 7.
    \nX Limited is considering to purchase of new plant worth \u20b9 80,00,000. The rate of cost of capital is 10%. You are required to calculate :<\/p>\n

    (a) Pay-back period
    \n(b) Net present value at 10 discount factor
    \n(c) Profitability index at 10 discount factor
    \n(d) Internal rate of return with the help of 10% and 15% discount factor.<\/p>\n

    The expected net cash flows after taxes and before depreciation and present value table are as follows :
    \n\"Investment
    \n(8 Marks May 2017)
    \nAnswer:
    \n(a) Payback period: = 14,00,000 + 14,00,000 + 14,00,000 + 14,00,000 + 14,00,000 + 10,00,000\/16,00,000 = 5.625 Years<\/p>\n

    (b) Calculation of NPV
    \n\"Investment
    \n\"Investment<\/p>\n

    (c) Calculation of PI: = PV of Inflow \u00f7 PV of Outflow
    \n= 97,92,200 \u00f7 80,00,000 = 1.224<\/p>\n

    (d) Calculation of IRR :
    \nNPV at 10% 1792,200
    \nNPV at 15% = 14,00,000 \u00d7 3.353 + 16,00,000 \u00d7 .432 + 20,00,000 \u00d7 .376 + 30,00,000 \u00d7 .327 + 2000,000 \u00d7 .284 + 8,00,000 \u00d7 .247 – 80,00,000
    \n= – 1,16,000
    \nIRR = L + \\(\\frac{\\mathrm{NPV}_{\\mathrm{L}}}{\\mathrm{NPV}_{\\mathrm{L}}-\\mathrm{NPV}_{\\mathrm{H}}}\\) \u00d7 H – L
    \n= 10% + \\(\\frac{17,92,200}{17,92,200(1,16,000)}\\) \u00d7 5% = 14.7%<\/p>\n

    Question 8.
    \nA firm can make investment in either of the following projects. The firm anticipates its cost of capital to be 10%. Pre-tax cash flows of the projects for five years are as follows :<\/p>\n\n\n\n\n\n
    Year<\/td>\n0<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n<\/tr>\n
    Project A (\u20b9)<\/td>\n(2,00,000)<\/td>\n35.000<\/td>\n80,000<\/td>\n90,000<\/td>\n75,000 ;<\/td>\n20,000<\/td>\n<\/tr>\n
    Project B (\u20b9)<\/td>\n(2,00,000)<\/td>\n2,18,000<\/td>\n10,000<\/td>\n10,000<\/td>\n4,000<\/td>\n3,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Ignore taxation. An amount of \u20b9 35,000 will be spent on account of sales promotion in year 3 in case of project A. This has not been taken into account in pre-tax cash inflows.
    \nThe discount factors are as under :<\/p>\n\n\n\n\n
    Year<\/td>\n0<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n<\/tr>\n
    PVF at 10%<\/td>\n1<\/td>\n0.91<\/td>\n0.83<\/td>\n0.75<\/td>\n0.68<\/td>\n0.62<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    You are required to calculate for each project;<\/p>\n

    (a) The payback period
    \n(b) The discounted payback period
    \n(c) Desirability factor
    \n(d) Net present value (8 Marks Nov. 2017)<\/p>\n

    Answer:<\/p>\n

    (a) Payback period:
    \nPayback period A = 35,000 + 80,000 + 55,000 + 30,000\/75,000 = 3.4 Years
    \nPayback period B = 2,00,000\/2,18,000 = 0.92 Years
    \nCalculation of Present Value of pre-tax cash inflows :
    \n\"Investment<\/p>\n

    (b) Discounted payback period:
    \nProject A = 31,850 + 66,400 + 41,250 + 51,000 + 9,500\/12,400 = 4.77 Years
    \nProject B = 1,98,380 + 1,620\/8,300 = 1.2 Years<\/p>\n

    (c) Desirability factor = PV of Inflow -F PV of Outflow
    \nProject A = 2,02,900 \u00f7 2,00,000 = 1.0145
    \nProject B = 2,18,760 \u00f7 2,00,000 = 1.0938<\/p>\n

    (d) NPV = PV of Inflow – PV of Outflow
    \nProject A = 2,02,900 – 2,00,000 = 2,900
    \nProject B = 2,18,760 – 2,00,000 = 18,760<\/p>\n

    Question 9.
    \nAT Limited is considering three projects A, B and C. The cash flows associated with the projects are given below :<\/p>\n\n\n\n\n\n\n
    Projects<\/td>\nC0<\/sub><\/td>\nC1<\/sub><\/td>\nC2<\/sub><\/td>\nC3<\/sub><\/td>\nC4<\/sub><\/td>\n<\/tr>\n
    A<\/td>\n(10,000)<\/td>\n2,000<\/td>\n2,000<\/td>\n6,000<\/td>\n0<\/td>\n<\/tr>\n
    B<\/td>\n(2,000)<\/td>\n0<\/td>\n2,000<\/td>\n4,000<\/td>\n6,000<\/td>\n<\/tr>\n
    C<\/td>\n(10,000)<\/td>\n2,000<\/td>\n2,000<\/td>\n6,000<\/td>\n10,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    You are required to:<\/p>\n

    (a) Calculate the payback period of each of the three projects.
    \n(b) If the cut-off period is two years, then which projects should be ac-cepted?
    \n(c) Projects with positive NPV\u2019s if the opportunity cost of capital is 10 per cent.
    \n(d) “Payback gives too much weight to cash flows that occur after the cut-off date\u201d. True or false?
    \n(e) \u201cIf a firm used a single cut-off period for all projects, it is likely to accept too many short lived projects.\u201d True or false?<\/p>\n

    Present value table:<\/p>\n\n\n\n\n
    Year<\/td>\n0<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n<\/tr>\n
    PVF@ 10%<\/td>\n1.000<\/td>\n0.909<\/td>\n0.826<\/td>\n0.751<\/td>\n0.683<\/td>\n0.621<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    (10 Marks May 2019)<\/p>\n

    Answer:<\/p>\n

    (a) Calculation of Cumulative Cash Flows:
    \n\"Investment
    \nPayback Period:<\/p>\n

    Project A = 3 Years
    \nProject B = 2 Years
    \nProject C = 3 Years<\/p>\n

    (b) If cut-off period is two years then company should accept<\/p>\n

    (c) NPV = Present value of Inflow – Present value of
    \nProject A = 2,000 \u00d7 0.909 + 2,000 \u00d7 0.826 + 6.000 \u00d7 0.75) – 10,000 = (2,024)
    \nProject B = 0 \u00d7 0.909 + 2,000 \u00d7 0.826 + 4,000 \u00d7 0.75 1 + 6,000 \u00d7 0.683 – 2,000 = 6,754
    \nProject C = 2,000 \u00d7 0.909 + 2,000 \u00d7 0.826 + 6,000 \u00d7 0.751 + 10.000 \u00d7 0.683 – 10,000 = 4,806<\/p>\n

    Project B and C have positive NPV.<\/p>\n

    (d) False : Pavback only considers cash flows from the initiation of the project till it\u2019s payback period is being reached, and ignores cash flows after the payback period.<\/p>\n

    (e) True : When a firm use a single cut-off period for all projects, it is likely to accept too many short lived projects having payback period within such cut-off date. Long term projects take time to reach at payback, in case of single cut-off date these long term projects arc ignored. Thus, payback is biased towards short-term projects.<\/p>\n

    \"Investment<\/p>\n

    Question 10.
    \nA company wants to buy a machine, and two different models namely A and B are available. Following further particulars are available :<\/p>\n\n\n\n\n\n\n
    Particulars<\/td>\nMachine A<\/td>\nMachine B<\/td>\n<\/tr>\n
    Original Cost (\u20b9)<\/td>\n8,00,000<\/td>\n6,00,000<\/td>\n<\/tr>\n
    Estimated life in years<\/td>\n4<\/td>\n4<\/td>\n<\/tr>\n
    Salvage value (\u20b9)<\/td>\n0<\/td>\n0<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    The company provides depreciation under straight line method. Income tax rate applicable is 30%. The present value of \u20b9 1 at 12% discounting factor and net profit before depreciation and tax are as under:
    \n\"Investment
    \nCalculate:<\/p>\n

    (1) NPV (Net Present Value)
    \n(2) Discounted Pay- back Period
    \n(3) PI (Profitability Index)<\/p>\n

    Suggest: Purchase of which machine is more beneficial under Discounted pay-back period method, NPV method and PI method. (10 Marks Jan. 2021)<\/p>\n

    Answer:<\/p>\n

    (1) NPV (Net Present Value) = PV of Inflows – PV of Outflows
    \nMachine A = 8,18,909 – 8,00,000 = 18,909
    \nMachine B = 6,17,425 – 6,00,000 = 17,425<\/p>\n

    (2) Discounted pay-back Period Machine A = 3 years + (8,00,000 – 5,31,437)\/2,87,472 = 3.93 years
    \nMachine B = 3 years + (6,00,000 – 5,22,025)\/95,400 = 3.82 years<\/p>\n

    (3) PI (Profitability Index) = PV of Inflows \u00f7 PV of Outflows
    \nMachine A = 8,18,909 \u00f7 8,00,000 = 1.023
    \nMachine B = 6,17,425 \u00f7 6,00,000 = 1.029<\/p>\n

    Suggestion : As per NPV method Machine A is more beneficial and as per Discounted pay-back period method and PI method Machine B is more bene-ficial.<\/p>\n

    Working Notes:<\/strong><\/p>\n

    1. Statement showing Present Value of CFAT and cumulative PV of CFAT of Machine A:
    \n\"Investment
    \n2. Statement showing Present Value of CFAT and cumulative PV of CFAT of Machine B :
    \n\"Investment<\/p>\n

    Unequal Life<\/strong><\/p>\n

    Question 11.
    \nAPZ limited is considering selecting a machine between two machines ‘A’ and \u2018B’ The two machines have identical capacity, do exactly the same job, but designed differently. Machine A costs \u20b9 8,00,000, having useful life of three years. It costs \u20b9 1,30,000 per year to run. Machine B is an economic model costing \u20b9 6,00,000, having useful life of two years. It costs \u20b9 2,50,000 per year to run.<\/p>\n

    The cash flows of machines \u2018A\u2019 and \u2018B\u2019 are real cash flows. The costs are forecasted in rupees of constant purchasing power. Ignore taxes. The opportunity cost of capital is 10%.<\/p>\n

    The present value factors at 10% are:
    \n\"Investment
    \nWhich machine would you recommend the company to buy? (8 marks Nov. 2013)
    \nAnswer:
    \nStatement Showing Evaluation of Two Machines
    \n\"Investment
    \nSelect the Machine A having lower equivalent annualized outflow.<\/p>\n

    Project Cost & Cost Of Capital<\/strong><\/p>\n

    Question 12.
    \nANP Ltd. Is providing the following information :
    \nAnnual cost of saving : \u20b9 96,000
    \nUseful life : 5 years
    \nSalvage value : zero
    \nInternal rate of return : 15%
    \nProfitability index : 1.05<\/p>\n

    Table of discount factor:
    \n\"Investment
    \nYou are required to calculate:<\/p>\n

    (a) Cost of the project
    \n(b) Payback period
    \n(c) Net present value of cash Inflow
    \n(d) Cost of capital (8 Marks May 2012)<\/p>\n

    Answer:<\/p>\n

    (a) Cost 0f the project:
    \nAt IRR.
    \nPV of inflows = PV of outflows
    \nPV of outflows = Annual cost of saving \u00d7 Cumulative discount factor @ IRR for 5 years
    \n= \u20b9 96,000 \u00d7 3.353
    \nCost of project = \u20b9 3,21,888<\/p>\n

    (b) Payback Period: \\(=\\frac{\\text { Initial Outflow }}{\\text { Equal Annual Cash Inflows \/ Saving }}\\) = \\(\\frac{3,21,888}{96,000}\\) = 3.353 year<\/p>\n

    (c) Net Present Value of cash inflows:
    \nPI \\(=\\frac{\\text { PV of Inflows }}{\\text { PV of Outflows }}\\)
    \n1.05 = \\(=\\frac{\\text { PV of Inflows }}{3,21,888}\\)
    \nPV of Inflows = 3.21,888 \u00d7 1.05 = \u20b9 3,3 7,982.4
    \nNPV = PV of inflows – PV of outflows
    \n= \u20b9 3,37,982.40 – \u20b9 3,21,888 = \u20b9 16,094.40<\/p>\n

    (d) Cost of Capital:
    \nCum DF @ cost of capital for 5 years \\(=\\frac{\\text { Present Value of Inflows }}{\\text { Annual Inflows }}\\)
    \n= \\(\\frac{3,37,982.40}{96,000}\\) = 3.52
    \nCost of Capital = 13% (Given in table)<\/p>\n

    \"Investment<\/p>\n

    Question 13.
    \nGiven below are the data on a capital project \u2018M\u2019:<\/p>\n

    Annual cash inflow : \u20b9 60,000
    \nUseful life : 4 years
    \nSalvage value : zero
    \nInternal rate of return : 15%
    \nProfitability index : 1.064<\/p>\n

    Table of discount factor:
    \n\"Investment<\/p>\n

    You are required to calculate;<\/p>\n

    (i) Cost of the project
    \n(ii) Payback period
    \n(iii) Cost of capital
    \n(iv) Net present value of cash inflow (8 Marks May 2015)<\/p>\n

    Answer:<\/p>\n

    (i) Cost of the project:
    \nAt IRR,
    \nPresent value of inflows = Present value of out flows
    \nPresent value of out flows = Annual cost of saving \u00d7 Cumulative discount factor @ IRR for 4 years
    \n= \u20b9 60,000 \u00d7 2.855
    \nCost of project = \u20b9 1,71,300<\/p>\n

    (ii) Payback Period: \\(=\\frac{\\text { Initial Outflow }}{\\text { Equal Annual Cash Inflows }}\\) = \\(\\frac{1,71,000}{60,000}\\)
    \n= 2.855 years<\/p>\n

    (iii) Cost of Capital:
    \nCum DF @ cost of capital for 4 years \\(=\\frac{\\text { Present Value of Inflows }}{\\text { Annual Inflows }}\\) = \\(\\frac{1,82,263.20}{60,000}\\)
    \n= 3.038<\/p>\n

    From the discount factor table, at discount rate of 12%, the cumulative discount factor for four years is 3.038 (0.893 + 0.797 + 0.712 4- 0.636)
    \nHence, Cost of capital = 12%<\/p>\n

    (iv) Net Present Value of cash inflows :
    \nPI \\(=\\frac{\\text { PV of Inflows }}{\\text { PV of Outflows }}\\)
    \n1.064 = \\(=\\frac{\\text { PV of Inflows }}{1,71,300}\\)
    \nPV of Inflows = 1,71,300 \u00d7 1.064 = \u20b9 1,82,263.2
    \n= PV of inflows – PV of outflows
    \n= \u20b9 1,82,263.20 – \u20b9 1,71,300 = \u20b9 10,963.20<\/p>\n

    Question 14.
    \nGiven below are the data on a capital project \u2018C\u2019:
    \nCost of the project : 12,28,400
    \nUseful life : 4 years
    \nSalvage value : zero
    \nInternal rate of return : 15%
    \nProfitability index : 1.0417<\/p>\n

    You are required to calculate:<\/p>\n

    (a) Annual cash flow
    \n(b) Cost of capital
    \n(c) Net present value (NPV)
    \n(d) Discounted Payback period<\/p>\n

    Table of discount factor:
    \n\"Investment
    \n(8 Marks May 2016)<\/p>\n

    Answer:<\/p>\n

    (a) Annual cash flow:
    \nAt IRR,
    \nPresent value of inflows = Present value of outflows
    \nPresent value of outflows = Annual cash inflow \u00d7 Cumulative discount factor @ IRR for 4 years
    \n2,28,400 = Annual cash inflow \u00d7 2.855
    \nAnnual cash Inflow = \u20b9 80,000<\/p>\n

    (b) Cost of Capital:
    \nPresent Value of inflows = Annual cash inflow \u00d7 Cumulative discount factor @ Cost of Capital for 4 years
    \nCost of project + NPV = 80,000 \u00d7 Cumulative discount factor @ Cost of Capital for 4 years
    \n2,28,400 + 9,524 = 80,000 \u00d7 PVIFA4<\/sub>
    \nPVIFA = 2.974
    \nCost of capital = 13%<\/p>\n

    Alternatively
    \n\"Investment
    \nCost of capital = 13%<\/p>\n

    From the discount factor table, at discount rate of 13%, the cumulative discount factor for four years is 2.974 (0.885 + 0.783 + 0.693 + 0.613)<\/p>\n

    (c) Nez Present Value (NPV): = Cost of project \u00d7 (PI – 1)
    \n= 2,28,400 \u00d7 (1.0417 – 1) = \u20b9 9,524<\/p>\n

    (d) Discounted Pay back Period = 3 years + \\(\\frac{2,28,400-1,88,80}{49,040}\\) = 3.806 years<\/p>\n

    Working notes:<\/strong><\/p>\n

    Calculation of PV of cash inflow cumulative PV of cash inflow:<\/p>\n\n\n\n\n\n\n\n
    Years<\/td>\nPV of cash inflow<\/td>\nCumulative PV of cash inflow<\/td>\n<\/tr>\n
    1<\/td>\n80,000 \u00d7 0.885 = 70,800<\/td>\n70,800<\/td>\n<\/tr>\n
    2<\/td>\n80,000 \u00d7 0.783 = 62,640<\/td>\n1,33,440<\/td>\n<\/tr>\n
    3<\/td>\n80,000 \u00d7 0.693 = 55,440<\/td>\n1,88,880<\/td>\n<\/tr>\n
    4<\/td>\n80,000 \u00d7 0.613 = 49,040<\/td>\n2,37,920<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    \"Investment<\/p>\n

    Question 15.
    \nA proposal to invest in a project, which has a useful life of 5 years and no salvage value at the end of useful life, is under consideration of a firm. It is anticipated that the project will generate a steady cash inflow of \u20b9 70,000 per annum. After analyzing other facts of the project, the following information were revealed :<\/p>\n

    Internal rate of return : 13%
    \nProfitability index : 1.07762<\/p>\n

    Table of discount factor:
    \n\"Investment<\/p>\n

    You are required to calculate:<\/p>\n

    (1) Cost of the project
    \n(2) Payback period
    \n(3) Net present value
    \n(4) Cost of capital (8 Marks May 2018)<\/p>\n

    Answer:<\/p>\n

    (1) Cost of the project:
    \nAt IRR,
    \nPresent value of inflows = Present value of outflows
    \nPresent value of outflows = Annual cash inflows \u00d7 Cumulative discount factor @ IRR for 5 years
    \n= \u20b9 70,000 \u00d7 3.517
    \nCost of the project = \u20b9 2,46,190<\/p>\n

    (2) Payback period \\(=\\frac{\\text { Initial Outflow }}{\\text { Annual Cash Inflow }}\\) = \\(\\frac{2,46,190}{70,000}\\) = 3.517 years<\/p>\n

    (3) Net Present Value:
    \nPI = \\(\\frac{2,65,299}{70,000}\\) \\(=\\frac{\\text { PV of Inflow }}{2,46,190}\\)
    \nPV of Inflows = \u20b9 2,46,190 \u00d7 1.07762 = \u20b9 2,65,299
    \nNPV = PV of inflows – PV of outflows
    \n= \u20b9 2,65299 – \u20b9 2,46,190 = \u20b9 19,109<\/p>\n

    (4) Cost of Capital: Cum DF @ cost of capital for 5 years \\(=\\frac{\\text { Present Value of Inflows }}{\\text { Annual Inflows }}\\) = \\(\\frac{2,65,299}{70,000}\\)
    \n= 3.790
    \nCost of capital = 10% (Given in table)<\/p>\n

    Capital Rationing<\/strong><\/p>\n

    Question 16.
    \nA company has \u20b9 1,00,000 available for investment and has identified the following four investment in which to invest:<\/p>\n\n\n\n\n\n\n\n
    Project Name<\/td>\nInitial Investment<\/td>\nNPV<\/td>\n<\/tr>\n
    C<\/td>\n\u20b9 40,000<\/td>\n\u20b9 20,000<\/td>\n<\/tr>\n
    D<\/td>\n\u20b9 1,00,000<\/td>\n\u20b9 35,000<\/td>\n<\/tr>\n
    E<\/td>\n\u20b9 50,000<\/td>\n\u20b9 24,000<\/td>\n<\/tr>\n
    F<\/td>\n\u20b9 60,000<\/td>\n\u20b9 18,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    You are required to optimise the returns from a package of projects within the capital spending limit if:<\/p>\n

    (a) The projects are independent of each other and are divisible.
    \n(b) The projects are not divisible. (5 Marks Nov. 2019)<\/p>\n

    Answer:<\/p>\n

    (a) Statement of Rank and Selection of Projects
    \n(Divisible Situation)
    \n\"Investment
    \nOptimum investment: 100% of C, E and 1\/10 of D.<\/p>\n

    (b) Statement of Possible Combinations and Combined NPV
    \n(Indivisible Situation)<\/p>\n\n\n\n\n\n\n
    Possible Combinations<\/td>\nCombined Investment<\/td>\nCombined NPV<\/td>\n<\/tr>\n
    C + E<\/td>\n\u20b9 90,000<\/td>\n\u20b9 44,000<\/td>\n<\/tr>\n
    C + F<\/td>\n\u20b9 1,00,000<\/td>\n\u20b9 38,000<\/td>\n<\/tr>\n
    D<\/td>\n\u20b9 1,00,000<\/td>\n\u20b9 35,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Invest in combination of C and E having highest combined NPV and invest remaining \u20b9 10,000 elsewhere.<\/p>\n

    Important Questions<\/strong><\/p>\n

    Question 1.
    \nXYZ Ltd. is planning to introduce a new product with a projected life of 8 years. The project to be set up in a backward region, qualifies for a one time (as its starting) tax free subsidy from the government of \u20b9 20,00,000 equipment cost will be \u20b9 140 lakhs and additional equipment costing \u20b9 10,00,000 wall be needed at the beginning of the third year.<\/p>\n

    At the end of 8 years the original equipment will have no resale value but the supplementary equipment can be sold for \u20b9 1,00,000. A working capital of \u20b9 5,00,000 will be needed. The sales volume over the eight years period has been forecasted as follows :
    \n\"Investment
    \nA sale price of \u20b9 100 per unit is expected and variable expenses will amount to 40% of sales revenue. Fixed cash operating costs will amount to \u20b9 16,00,000 per year. In addition an extensive advertising campaign will be implemented requiring annual outlays as follows :
    \n\"Investment
    \nThe company is subject to 50% tax rate and considers 12% to be an appropriate after tax cost of capital for this project. The company follows the straight line method of depreciation.
    \nShould the project be accepted?
    \nAnswer:
    \nNet Present Value
    \n\"Investment
    \nCompany should accept the proposal having positive NPV of the project. Working Notes:<\/p>\n

    Working Notes:<\/strong><\/p>\n

    1. Statement of CFAT
    \n\"Investment
    \n\"Investment<\/p>\n

    2. Depriciation :
    \n\"Investment<\/p>\n

    3. Tax for year 2 = 50% of (26,00,000 – 13,00,000) = 6,50,000<\/p>\n

    Note : As per section 32 of Income Tax Act \u201cDepreciation is not allowed on subsidized part of asset\u201d<\/p>\n

    \"Investment<\/p>\n

    Question 2.
    \nA Company is considering a proposal of installing a drying equipment. The equipment would involve a cash outlay of \u20b9 6,00,000 and net Working Capital of \u20b9 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.
    \nThe estimated before-tax cash inflows are given below :<\/p>\n\n\n\n\n
    year<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n<\/tr>\n
    Before tax cash<\/td>\n\u20b9 2,40,000<\/td>\n\u20b9 2,75,000<\/td>\n\u20b9 2,10,000<\/td>\n\u20b9 1,80,000<\/td>\n\u20b91,60,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    The applicable Income-tax rate to the Company is 35%. If the Company\u2019s opportunity cost of capital is 12%, calculate the equipment\u2019s net present value, discounted payback period, payback period, and internal rate of return.<\/p>\n

    The PV factors at 12%, 14% and 15% are :
    \n\"Investment
    \nAnswer:
    \n(1) Net Present Value
    \n\"Investment<\/p>\n

    Working Notes:<\/strong><\/p>\n

    Calculation of CFAT:
    \n\"Investment<\/p>\n

    (2) Discounted Payback Period = 4 years + \\(\\frac{6,80,000-5,80,877}{1,28,234}\\) = 4.77 years<\/p>\n

    (3) Payback Period = 3 years + \\(\\frac{6,80,000-5,97,250}{1,59,000}\\) = 3.52 years<\/p>\n

    (4) Internal Rate of Return :<\/p>\n

    Calculation of NPV by Using DF @ 12% and 14%
    \n\"Investment
    \n\"Investment<\/p>\n

    Question 3.
    \nA Ltd. Is considering the purchase of a machine which will perform some operations which are at present preformed by workers. Machines X and Y are alternative models. The following details are available :
    \n\"Investment<\/p>\n

    Depreciation will be charged on straight line basis. The tax rate is 30%. Evaluate the alternation according to :<\/p>\n

    (a) Average rate of return method, and
    \n(b) Present value index method assuming cost of capital being 10%.
    \n(The present value of \u20b9 1.00 @ p.a. for 5 years is 3.79 and for 6 years is 4.354)<\/p>\n

    Answer:<\/p>\n

    (a) Statement Showing Evaluation of Two Machines (ARR)
    \n\"Investment
    \n\"Investment<\/p>\n

    (b) Statement Showing Evaluation of Two Machines (PI)
    \n\"Investment<\/p>\n

    Question 4.
    \nLockwood Limited wants to replace its old machine with a new automatic machine. Two models A and B are available at the same cost of \u20b9 5 lakhs each. Salvage value of the old machine is \u20b9 1 lakh. The utilities of the existing machine can be used if the company purchases A.<\/p>\n

    Additional cost of utilities to be purchased in that case are \u20b9 1 lakh. If the company purchases B then all the existing utilities will have to be replaced with new utilities costing \u20b9 2 lakhs. The salvage value of the old utilities will be \u20b9 0.20 lakhs. The cash flows after taxation are expected to be :
    \n\"Investment
    \n\"Investment<\/p>\n

    The targeted return on capital is 15%. You are required to:<\/p>\n

    (a) Compute, for the two machines separately, Net Present Value, Dis-counted Payback Period and Desirability Factor and
    \n(b) Advice which of the machines is to be selected?<\/p>\n

    Answer:<\/p>\n

    (a) Net Present Value
    \n\"Investment<\/p>\n

    Discounted Payback Period
    \n\"Investment<\/p>\n

    Machine A = 4 years + \\(\\frac{5,00,000-4,33,085}{1,09,384}\\) = 4.612 years
    \nMachine B = 4 years + \\(\\frac{5,80,000-5,48,257}{49,720}\\) = 4.638 years
    \nProfitability Index(PI) \\(=\\frac{\\text { PV of Inflows }}{\\text { PV of Outflows }}\\)
    \nMachine A = \\(\\frac{5,42,469}{5,00,000}\\) = 1.085
    \nMachine B = \\(\\frac{5,97,977}{5,80,000}\\) = 1.031<\/p>\n

    Working note:<\/strong><\/p>\n

    Calculation of Initial Investment
    \n\"Investment<\/p>\n

    (b) Since the absolute surplus in the case of A is more than B and also the desirability factor, it is better to choose A. The discounted payback period in both the cases is same, also the net present value is positive in both the cases but the desirability factor (profitability index) is higher in the case of Machine A, it is therefore better to choose Machine A.<\/p>\n

    \"Investment<\/p>\n

    Question 5.
    \nHindlever Company is considering a new product line to supplement its range line. It is anticipated that the new product line will involve cash investments of \u20b9 7,00,000 at time 0 and \u20b9 10,00,000 in year 1.<\/p>\n

    After-tax cash inflows of \u20b9 2,50,000 are expected in year 2, \u20b9 3,00,000 in year 3, \u20b9 3,50,000 in year 4 and \u20b9 4,00,000 each year thereafter through year 10. Although the product line might be viable after year 10, the company prefers to be conservative and end all calculations at that time.<\/p>\n

    (a) If the required rate of return is 15 per cent, what is the net present value of the project? Is it acceptable?
    \n(b) What would be the case if the required rate of return were 10 per cent?
    \n(c) What is its internal rate of return?
    \n(d) What is the project\u2019s payback period?<\/p>\n

    Answer:<\/p>\n

    (a) Statement of NPV
    \n\"Investment<\/p>\n

    (b) Statement of NPV
    \n\"Investment<\/p>\n

    (c)
    \n\"Investment<\/p>\n

    (d) Payback Period = -7,00,000 – 10,00,000 + 2,50,000 + 3,00,000 + 3,50,000 + 4,00,000 + 4,00,000
    \n= 6 Years<\/p>\n

    Question 6.
    \nElite Cooker Company is evaluating three investment situations :<\/p>\n

    (1) produce a new line of aluminum skillets,
    \n(2) expand its existing cooker line to include several new sizes, and
    \n(3) develop a new, higher-quality line of cookers. If only the project in question is undertaken, the expected present values and the amounts of investment required are :<\/p>\n\n\n\n\n\n\n
    Project<\/td>\nInvestment required<\/td>\nPresent value of future cash flows<\/td>\n<\/tr>\n
    1<\/td>\n\u20b9 2,00,000<\/td>\n\u20b9 2,29,000<\/td>\n<\/tr>\n
    2<\/td>\n\u20b9 1,15,000<\/td>\n\u20b9 1,85,000<\/td>\n<\/tr>\n
    3<\/td>\n\u20b9 2,70,000<\/td>\n\u20b9 4,00,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    If projects 1 and 2 are jointly undertaken, there will be no economies; the investments required and present values will simply be the sum of the parts. With projects 1 and 3, economies are possible in investment because one of the machines acquired can be used in both production processes.<\/p>\n

    The total investment required for projects 1 and 3 combined is \u20b9 4,40,000. If projects 2 and 3 are undertaken, there are economies to be achieved in marketing and producing the products but not in investment.<\/p>\n

    The expected present value of future cash flows for projects 2 and 3 is \u20b9 6,20,000. If all three projects are undertaken simultaneously, the economies noted will still hold. However, a \u20b9 1,25,000 extension on the plant will be necessary, as space is not available for all three projects.
    \nWhich project or projects should be chosen ?<\/p>\n

    Answer:<\/p>\n

    Statement of Cumulative NPV of Different Combinations
    \n\"Investment<\/p>\n

    Calculation of total investment required if all the three projects are undertaken simultaneously:<\/p>\n

    ‘Totalinvestment = Investment in projects 1 & 3 + Investment in project 2 + Plant extension cost
    \n= 4,40,000 + 1,15,000 + 1,25,000 = 16,80,000<\/p>\n

    Advise : Projects 1 and 3 should be chosen, as they provide the highest net present value.<\/p>\n

    Question 7.
    \nAlley Pvt. Ltd. is planning to invest in a machinery that would cost \u20b9 1,00,000 at the beginning of year 1. Net cash inflows from operations have been estimated at \u20b9 36,000 per annum for 3 years. The company has two options for smooth functioning of the machinery: one is service, and another is replacement of parts. If the company opts to service a part of the machinery at the end of year 1 at \u20b9 20,000, in such a case, the scrap value at the end of year 3 will be \u20b9 25,000.<\/p>\n

    However, if the company decides not to service the part, then it will have to be replaced at the end of year 2 at \u20b9 30,800 and in this case, the machinery will work for the 4th year also and get operational cash inflow of \u20b9 36,000 for the 4th year. It will have to be scrapped at the end of year 4 at \u20b9 18,000.<\/p>\n

    Assuming cost of capital at 10% and ignoring taxes, determine the purchase of this machinery based on the net present value of its cash flows?<\/p>\n

    If the supplier gives a discount of \u20b9 10,000 for purchase, what would be your decision?
    \nThe PV factors at 10% are :<\/p>\n\n\n\n\n
    Year<\/td>\n0<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n6<\/td>\n<\/tr>\n
    PV Factor<\/td>\n1<\/td>\n0.9091<\/td>\n0.8264<\/td>\n0.7513<\/td>\n0.6830<\/td>\n0.6209<\/td>\n0.5645<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Answer:
    \nOption 1 (Part of the Machine is serviced) :<\/p>\n

    Statement of NPV
    \n\"Investment<\/p>\n

    Option 2 (Part of the Machine is replaced):<\/p>\n

    Statement of NPV
    \n\"Investment<\/p>\n

    Decision : Option I has a negative NPV whereas option II has a positive NPV \u20b9 954. Therefore, option II (replacement of part) shall be opted.<\/p>\n

    If the supplier gives a discount of \u20b9 10,000 for purchases:<\/p>\n

    Option 1: NPV = (9,875) + 10,000 = 125
    \nOption 2: NPV = 954 + 10,000 = 10,954<\/p>\n

    Decision : Option I with very small NPV is not considerable, Option II having higher NPV shall be opted (student can also show annualized NPV due to difference in life of projects).<\/p>\n

    \"Investment<\/p>\n

    Question 8.
    \nMNP Limited is thinking of replacing its existing machine by a new machine which would cost \u20b9 60 lakhs. The company\u2019s current production is \u20b9 80,000 units, and is expected to increase to 1,00,000 units, if the new machine is bought. The selling price of the product would remain unchanged at \u20b9 200 per unit. The following is the cost of producing one unit of product using both the existing and new machine :
    \n\"Investment<\/p>\n

    The existing machine has an accounting hook value of \u20b9 1,00,000, and it has been fully depreciated for tax purpose. It is estimated that machine will be useful for 5 years. The supplier of the new machine has offered to accept the old machine for \u20b9 2,50,000.<\/p>\n

    However, the market price of old machine today is \u20b9 1,50,000 and it is expected to be \u20b9 35,000 after 5 years. The new machine has a life of 5 years and a salvage value of \u20b9 2,50,000 at the end of its economic life.<\/p>\n

    Assume corporate Income tax rate at 40%, and depreciation is charged on straight line basis for Income-tax purposes. Further assume that book profit is treated as ordinary income for tax purpose. The opportunity cost of capital of the Company is 15%.<\/p>\n

    Required:<\/p>\n

    (i) Estimate net present value of the replacement decision.
    \n(ii) Estimate the internal rate of return of the replacement decision.
    \n(iii) Should Company go ahead with the replacement decision? Suggest.
    \n\"Investment
    \nAnswer:
    \n(i) Statement of NPV
    \n\"Investment<\/p>\n

    Working Notes:<\/strong><\/p>\n

    1. Calculation of initial outflow:
    \nCost of new machine : \u20b9 60,00,000
    \nLess : Exchange value of old machine : (\u20b9 2,50,000)
    \nAdd : Tax payment on profit on exchange of old machine (2,50,000 – Nil) \u00d7 40% : \u20b9 1,00,000
    \nInitial outflow : \u20b9 58,50,000<\/p>\n

    2. Calculation of incremental CFAT:<\/p>\n

    Increase in sales (200 \u00d7 20,000 units) \u20b9 40,00,000
    \nLess : Increase in operating cost (1,00,000 \u00d7 148) – (80,000 \u00d7 173) (excluding Depreciation and Allocated overheads) : \u20b9 9,60,000
    \nLess : Increase in depreciation [(60,00,00 – 2,50,000) \u00f7 5] – Nil : \u20b9 11,50,000
    \nProfit before tax : \u20b9 18,90,000
    \nLess : Tax @ 40% : \u20b9 7,56,000
    \nProfit after tax : \u20b9 11,34,000
    \nAdd: Depreciation : \u20b9 11,50,000
    \nIncremental CFAT \u20b9 22,84,000<\/p>\n

    3. Calculation of Incremental Salvage:
    \n\"Investment<\/p>\n

    Notes :<\/strong><\/p>\n

    (a) The old machine could be sold for \u20b9 1,50,000 in the market. Since ex-change value is more than the market value, company will exchange it at \u20b9 2,50,000.
    \n(b) Old machine has fully depreciated for tax purpose, therefore depreciation of old machine as well as WDV are NIL.
    \n(c) Allocated overheads are allocations from corporate office therefore they are irrelevant for computation of CFAT.<\/p>\n

    (ii) Calculation of IRR :<\/p>\n

    Since NPV computed in Part (i) is positive. Let us discount cash flows at higher rate say at 25% or 30%
    \nStatement of NPV
    \n\"Investment
    \nIRR = 25% + \\(\\frac{3,67,404}{3,67,404+2,25,648}\\) \u00d7 5% = 28.10%<\/p>\n

    (iii) Advise : The company should go ahead with replacement project, since it has positive NPV.<\/p>\n

    Question 9.
    \nAPZ limited is considering selecting a machine between two machines ‘A’ and \u2018B’. The two machines have identical capacity, do exactly the same job, but designed differently.<\/p>\n

    Machine A costs \u20b9 8,00,000, having useful life of three years. It costs \u20b9 1,30,000 per year to run. Machine B is an economic model costing \u20b9 6,00,000, having .iseful life of two years. It costs \u20b9 2,50,000 per year to run.<\/p>\n

    The cash flows of machines \u2018A\u2019 and \u2018B\u2019 are real cash flows. The costs are forecasted in rupees of constant purchasing power. Ignore taxes. The opportunity cost of capital is 10%.
    \nThe present value factors at 10% are :
    \n\"Investment
    \nWhich machine would you recommend the company to buy?
    \nAnswer:
    \n\"Investment
    \nSelect the Machine A having lower equivalent annualized outflow<\/p>\n

    Question 10.
    \nTotal fund available is \u20b9 3,00,000. Determine the optimal combination of projects assuming that the projects are<\/p>\n

    (a) Divisible or
    \n(b) Indivisible.
    \n\"Investment
    \nAnswer:
    \n(a) Statement of Rank and Selection of Projects
    \n(Divisible Situation)
    \n\"Investment
    \nOptimum investment: 100% of P, R, T and 1\/4 of S.<\/p>\n

    (b) Statement of Possible Combinations and Combined NPV
    \n(Indivisible Situation)
    \n\"Investment
    \nInvest in combination of P, R and T having highest combined NPV and invest remaining \u20b9 50,000 elsewhere.<\/p>\n

    \"Investment<\/p>\n

    Question 11.
    \nUsing details given below, calculate MIRR considering 8% cost of Capital. Year Cash Plow
    \n\"Investment
    \nAnswer:
    \nStatement of Compounding Value
    \n\"Investment
    \n\"Investment<\/p>\n

    Calculation of MIRR :<\/p>\n

    Compound Factor \\(=\\frac{\\text { Compound value of inflow }}{\\text { Initial outflow }}\\) = \\(\\frac{2,13,587}{1,36,000}\\) = 1.5705
    \nMIRR = \\(\\sqrt[5]{1.5705}\\) – 1 = 9.45%<\/p>\n

    Question 12.
    \nA large profit making company is considering the installation of a machine to process the waste produced by one of its existing manufacturing process to be converted into a marketable product. At present, the waste is removed by a contractor for disposal on payment by the company of \u20b9 150 lakh per annum for the next four years.<\/p>\n

    The contract can be terminated upon installation of the aforesaid machine on payment of a compensation of \u20b9 90 lakh before the processing operation starts. This compensation is not allowed as deduction for tax purposes.<\/p>\n

    The machine required for carrying out the processing will cost \u20b9 600 lakh to be financed by a loan repayable in 4 equal instalments commencing from end of the year 1. The interest rate is 14% per annum. At the end of the 4th year, the machine can be sold for \u20b9 60 lakh and the cost of dismantling and removal will be \u20b9 45 lakh.<\/p>\n

    Sales and direct costs of the product emerging from waste processing for 4 years are estimated as under :
    \n\"Investment
    \nInitial stock of materials required before commencement of the processing operations is \u20b9 60 lakh at the start of year 1. The stock levels of materials to be maintained at the end of year 1, 2 and 3 will be \u20b9 165 lakh and the stocks at the end of year 4 will be nil. The storage of materials will utilise space which would otherwise have been rented out for \u20b9 30 lakh per annum.<\/p>\n

    Labour costs include wages of 40 workers, wrhose transfer to this process will reduce idle time payments of \u20b9 45 lakh in the year 1 and \u20b9 30 lakh in the year 2. Factory overheads include apportionment of general factory overheads except to the extent of insurance charges of \u20b9 90 lakh per annum payable on this venture. The company\u2019s tax rate is 30%.<\/p>\n

    Present value factors for four years are as under:<\/p>\n\n\n\n\n
    Year<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n<\/tr>\n
    PV Factors<\/td>\n0.877<\/td>\n0.769<\/td>\n0.674<\/td>\n0.592<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Advise the management on the desirability of installing the machine for processing the waste. All calculations should form part of the answer.
    \nAnswer:
    \nNet present Value
    \n\"Investment<\/p>\n

    Advice : Since the net present value of cash flows is \u20b9 577.37 lakhs which is positive the management should install the machine for processing the waste.<\/p>\n

    Working Notes:<\/strong><\/p>\n

    Statement of CFAT
    \n\"Investment
    \n\"Investment
    \nNote : Income tax saving loss on sale of machine at the end of the project is ignored, student may calculate loss on sale of machine and tax saving.<\/p>\n","protected":false},"excerpt":{"rendered":"

    Investment Decisions \u2013 CA Inter FM Study Material is designed strictly as per the latest syllabus and exam pattern. Investment Decisions \u2013 CA Inter FM Study Material Theory Questions Question 1. Distinguish between Net Present Value method and Internal Rate of Return method. (4 Marks Nov. 2011, Nov. 2015) Answer: NPV: NPV or net present …<\/p>\n

    Investment Decisions \u2013 CA Inter FM Study Material<\/span> Read More »<\/a><\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"spay_email":"","footnotes":""},"categories":[167],"tags":[],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/16401"}],"collection":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/comments?post=16401"}],"version-history":[{"count":10,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/16401\/revisions"}],"predecessor-version":[{"id":16575,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/16401\/revisions\/16575"}],"wp:attachment":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/media?parent=16401"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/categories?post=16401"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/tags?post=16401"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}