*1 Cash Flow estimation in Capital Budgeting solved problems pdf Capital Budgeting numericals with solutions pdf Capital Budgeting Notes pdf RBL Academy Financial management notes pdf

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Capital Budgeting numerical with solutions

Initial Cash Outflow = Cost of new plant +Installation Expenses +Other Capital Expenditure+ Additional Working Capital - Tax benefit on account of Capital loss on sale of old plant (if any) - Salvage value of old plant +Tax Liability on account of Capital gain on sale of old plant (if any).

Subsequent Cash inflow = Profit after Tax+ Depreciation+ Financial charge (1 - t) Repairs (if any) - Capital Expenditure (if any).

Terminal Cash inflow = Salvage value of asset ± Tax on capital gain / loss on sale of asset + Working Capital released.

1. The cost of a machine is 10, 00,000. It has an estimated life of 10 years after which it would be disposed off (scrap value nil). Profit or Earning before depreciation and taxes (EBDT/PBDT) is estimated to be 2, 75,000 p.a. Find out the yearly cash flow from the machinery, (given the tax rate @ 40%).

Solution

Depreciation = Cost of machine/ estimated life of machine = Rs. 10,00,000/10 = Rs. 1,00,000

Particulars	Amount (Rs.)
EBDT /PBDT	2,75,000
Less: Depreciation	(1,00,000)
PBT /EBT	1,75,000
Less Tax @ 40 % of EBT/PBT	(70,000)
PAT/EAT	1,05,000
Add: Depreciation	1,00,000
Cash flow	2,05,000

 

2. ABC LLP is evaluating a capital budgeting proposal for which relevant figures are as follows:

Cost of the Plant 10,00,000

Installation cost 1, 00,000

Economic life 5 years

Scrap value Rs. 50,000

Profit before depreciation and tax Rs. 4,00,000 and Tax rate 40 %.

Solution

Depreciation = cost of plant + Installation cost – Scrap or Salvage value / economic life of plant

= (10,00,000 + 1,00,000 – 50,000) /5 = Rs. 2,10,000

Particulars	Amount (Rs.)
EBDT /PBDT	4,00,000
Less: Depreciation	(2,10,000)
PBT /EBT	1,90,000
Less Tax @ 40 % of EBT/PBT	(76,000)
PAT/EAT	1,14,000
Add: Depreciation	2,10,000
Cash flow	3,24,000

 

3. A firm buys an asset costing 10,00,000 and expects operating profits (before depreciation and tax) of 3,00,000 p.a. for the next four years after which the asset would be disposed off for 4,50,000. Find out the cash flows for different years. Also calculate terminal cash flow. Depreciation is to be charged at 20 % p.a. on WDV basis and rate of tax is 30 %.

Solution

Initial cash outflow = Rs. 10,00,000

Terminal Cash inflow = Salvage value ± Tax on Gain/loss of asset

= Rs. 4,50,000 – Tax on gain on sale of asset

= Rs. 4,50,000 – (30 % of Rs.40,400)  = Rs. 4,50,000 – Rs. 12,120 = Rs. 4,37,880

Capital Gain on sale of asset = Scrap value of asset – WDV of asset at the time of disposal

= Rs. 4,50,000 – RS. 4,09,600 = Rs.40,400

Note: In case of gain, tax amount on gain on sale of asset will be subtracted. In case of loss, tax amount on loss on sale of asset will be subtracted

Capital Loss on sale of asset = WDV of asset at the time of disposal- Scrap value of asset

	Year 1 (Rs.)	Year 2(Rs.)	Year 3(Rs.)	Year 4(Rs.)
PBDT	3,00,000	3,00,000	3,00,000	3,00,000
Less Depreciation	(2,00,000)	(1,60,000)	(1,28,000)	(1,02,400)
PBT	1,00,000	1,40,000	1,72,000	1,97,600
Less Tax @30 % of PBT	(30,000)	(42,000)	(51,600)	(59,280)
PAT	70,000	98,000	1,20,400	1,38,320
Add Depreciation	2,00,000	1,60,000	1,28,000	1,02,400
Cash Flow	2,70,000	2,58,000	2,48,000	2,40,720
Terminal Cash Flow				Rs. 4,37,880

 Calculation on Depreciation

	Year 1(Rs.)	Year 2(Rs.)	Year 3(Rs.)	Year 4(Rs.)	Year 5(Rs.)
WDV	10,00,000	10,00,000- 2,00,000 = 8,00,000	8,00,000 –1,60,000 = 6,40,000	6,40,000 - 1,28,000 = 5,12,000	5,12,000- 1,02,400 = 4,09,600
Depreciation	20 % of 10,00,000 = 2,00,000	20 % of 8,00,000 = 1,60,000	20 % of Rs. 6,40,000 = Rs. 1,28,000	20 % of 5,12,000 = 1,02,400

4. From following income statement of project determine annual cash flow for the company.

Income Statement of the Project
Net Sales revenue	7,70,000
- Cost of Goods Sold	(3,00,000)
- General Expenses	(1,50,000)
- Depreciation	(70,000)
Profit before interest and taxes	2,50,000
- Interest	(50,000)
Profit before tax	2,00,000
- Tax@ 30%	(60,000)
Profit after tax	1,40,000

 

Solution

Cash flow of the Project
Net Sales revenue	7,70,000
- Cost of Goods Sold	(3,00,000)
- General Expenses	(1,50,000)
- Depreciation	(70,000)
Profit before interest and taxes	2,50,000
- Tax@ 30%	(75,000)
Profit after tax	1,75,000
Add: Depreciation	70,000
Cash Flow	2,45,000

 Note: In the capital budgeting decision process, cash inflows in the form of raising the funds and cash outflows in the form of interest and dividend payments, are ignored.

The cash inflow arising at the time of raising of additional fund results in an immediate cash outflow also when these funds are used to procure the project. As such, there is no net cash inflow. Further, the cost of financing in the form of interest and dividend is truly reflected in the weighted average cost of capital which is used to evaluate the proposals. If the cost of debt or equity (ie, interest or dividends) is deducted from the cash inflows, then this cost of raising fund will be counted twice, first in the cash inflows and second, in the weighted average cost of capital. This is also known as Interest Exclusion Principle.

The interest payable to the lenders and the dividend payable to the shareholders are cash flows to the supplier of funds and not cash flow from the project. In capital budgeting, the cash flow from the project is compared with the cost of acquiring that project. A particular capital mix, the firm uses to finance the project is a managerial variable and primarily determines how project cash flows are divided between lenders and owners.

Thus, neither, the additional funds raised nor the interest/ dividend payable on these funds are treated as relevant cash flows for a proposal. Otherwise, there will be an error of double counting. The general principle is that the investment decision and the financing decision should be considered Separately. In other words, only the operating cash flows of a proposal should be brought into and evaluated in the capital budgeting process. The financial cash flows should be taken as constant and be kept outside the analysis.

5. RBL Ltd is planning to install a new machine costing Rs. 20,00,000 with a salvage value of Rs. 5,00,000 after 4  years of life. Following information is available in respect of the machine. Annual Production of the company will be 1,00,000 Units for year 1 and it will increase by 10 % p.a. over immediate preceding year production for next 3 years. Selling price = Rs. 20 per unit, Variable cost = Rs. 10 per unit, Fixed cost 3,00,000 p.a., Tax rate is 30 %. Depreciation is to be charged at 25 % on written Down Value. Calculate initial, subsequent and terminal cash flow of the machine.

Solution

Initial outflow for the machine = Rs. 20,00,000.

Subsequent cash inflow:

Particulars	Year 1 (Rs.)	Year 2(Rs.)	Year 3(Rs.)	Year 4(Rs.)
Sales in units	100000 units	110000 units	121000 units	133100 units
Selling Price per unit (Rs)	20	20	20	20
Total Sales	20,00,000	22,00,000	24,20,000	26,62,000
less: Variable cost (VC/unit × no. of units)	(10,00,000)	(11,00,000)	(12,10,000)	(13,31,000)
less: Fixed cost	(3,00,000)	(3,00,000)	(3,00,000)	(3,00,000)
EBDT	7,00,000	8,00,000	9,10,000	10,31,000
Less :Depreciation	(5,00,000)	(3,75,000)	(2,81,250)	(2,10,937.5)
EBT	2,00,000	4,25,000	6,28,750	8,20,062.5
less: Tax @30 % of EBT	(60,000)	(1,27,500)	(1,88,625)	(2,46,018.75)
PAT	1,40,000	2,97,500	4,40,125	5,74,043.75
Add: Depreciation	5,00,000	3,75,000	2,81,250	2,10,937.5
Annual Cash Inflow	6,40,000	6,72,500	7,21,375	7,84,981.25
Terminal Cash inflow				Rs. 5,39,843.75

 Calculation of Depreciation:

	Year 1(Rs.)	Year 2(Rs.)	Year 3(Rs.)	Year 4(Rs.)	Year 5(Rs.)
WDV	20,00,000	20,00,000- 5,00,000 = 15,00,000	15,00,000 –3,75,000 = 11,25,000	11,25,000 - 2,81,250 = 8,43,750	8,43,750- 2,10,937.5= 6,32,812.5 (WDV at the time of disposal)
Depreciation	25 % of 20,00,000 = 5,00,000	25 % of 15,00,000 = 3,75,000	25 % of Rs. 11,25,000 = Rs. 2,81,250	25 % of 8,43,750= 2,10,937.5

 Calculation of terminal cash inflow

Terminal Cash inflow = Salvage value ± Tax on Gain/loss of asset

In this case there is a capital loss since Rs. 6,32,812.5 (WDV at the time of disposal) is more than Rs. 5,00,000 (Salvage value of asset)

= Rs. 5,00,000 + Tax saving on loss on sale of asset

= Rs. 5,00,000 + (30 % of Rs. 1,32,812.5)  = Rs. 5,00,000 + Rs. 39,843.75 = Rs. 5,39,843.75

Capital Loss on sale of asset = WDV of asset at the time of disposal- Scrap value of asset               

Capital Gain on sale of asset = Scrap value of asset – WDV of asset at the time of disposal

Note: While calculating Terminal cash inflow; In case of capital gain, tax amount on gain on sale of asset will be subtracted. In case of capital loss, tax amount on loss on sale of asset will be added as it indicates saving for the company due to appropriation of capital losses with other gains of the company.

6. RBL Ltd. is planning to purchase a machine for Rs. 2,00,000 which will help company to generate following earnings in the next five years

Years	Year 1	Year 2	Year 3	Year 4	Year 5
EBDT	60,000	65,000	68,000	70,000	70,000

 The purchase of machine will result in increase of working Capital by 20,000. The machine will be depreciated on SLM basis and has salvage value of Rs. 50,000. The company is subject to tax at the rate of 40 per cent. Calculate initial, subsequent and terminal cash flow of the machine.

Solution:

Cash outflow in the beginning = Cost of Machine + Working Capital

= Rs. 2,00,000 + Rs. 20,000 = Rs. 2,20,000

Terminal Cash flow = Salvage value + Working Capital = Rs. 50,000 + Rs. 20,000 = Rs. 70,000.

Depreciation = cost of machine +Salvage value / estimated life of project

= (Rs. 2,00,000 – Rs. 50,000) / 5 = Rs. 30,000

	Year 1	Year 2	Year 3	Year 4	Year 5
EBDT	60,000	65,000	68,000	70,000	70,000
Less: Depreciation	(30,000)	(30,000)	(30,000)	(30,000)	(30,000)
EBT	30,000	35,000	38,000	40,000	40,000
Less: Tax @ 40 %	(12,000)	(14,000)	(15,200)	(16,000)	(16,000)
PAT	18,000	21,000	22,800	24,000	24,000
ADD: Depreciation	40,000	40,000	40,000	40,000	40,000
Annual Cash Inflow	58,000	61,000	62,800	64,000	64,000
Terminal Cash inflow					Rs. 70,000

 

7. Vikalpa Limited is considering to purchase an asset having an estimated life of 4 years which will cost Rs. 13,00,000 with Installation cost of Rs. 2,00,000. There will be an Increase in working capital in the beginning of the year of Rs. 3,50,000. Scrap value of the new asset after 4 years will be Rs. 4,00,000. Revenues for entire life of machine from new asset is 25,00,000 p.a. other information is as follows:

Annual Cash expenses on new asset Rs. 11,00,000

Book value of old asset today is Rs. 5,00,000

Salvage value of old asset if sold today Rs. 6,00,000

Revenue generated from old asset annually Rs. 19,50,000

Annual Cash expenses of old asset Rs. 12,00,000

Depreciation on new asset is to be charged on 80% of the cost in the ratio of 4:8:6:2 over four years.

Existing asset is to be depreciated at a rate of Rs. 1,25,000 p.a. Tax rate is 30 % on revenues as well as on capital gains / losses. Calculate initial, subsequent and terminal cash flow of the machine. Calculate cash inflow from new machine, cash inflow from old machine, incremental cash inflow, terminal cash inflow and cash outflow for the information provided.

Solution

Initial Cash Outflow = Purchase price of asset + installation cost + Working Capital increase – Salvage/Scrap value of old asset ± Tax on Capital gain/loss on sale of old asset

In this case Salvage value of old asset is Rs.6,00,000 and book value is Rs. 5,00,000. Hence there is a capital gain of Rs. 1,00,000

Capital gain = Salvage value of asset – Book value of asset

Capital loss = Book value of asset – salvage value of asset

Note: There is Capital Gain in case Salvage/Scrap value > Book value and Capital loss in case Book value > Salvage /Scrap value.

While calculating initial cash outflow; Tax on capital loss on sale of asset is subtracted from initial cash outflow and tax on capital gain on sale of asset is added to initial cash outflow.

Initial cash outflow = Rs. 13,00,000 + Rs. 2,00,000 + Rs. 3,50,000 – Rs. 6,00,000 + 30 % of (Rs. 6,00,000 – Rs. 5,00,000) = Rs. 12,80,000.

Depreciation calculation:

Depreciation on new asset is to be charged on 80% of the cost in the ratio of 4:8:6:2 over four years.

So, cost of machine for depreciation purpose according to question = 80 % of (purchase price + installation cost) = 80 % of (Rs. 13,00,000 + Rs. 2,00,000) = Rs. 12,00,000.

Rs. 12,00,000 will be depreciated in the ratio of 4:8:6:2 over four years.

ð  4+8+6+2 = 20

Depreciation year wise:

	Year 1	Year 2	Year 3	Year 4
Depreciation	Rs. 12,00,000 × 4/20 = Rs. 2,40,000	Rs. 12,00,000 × 8/20 = Rs. 4,80,000	Rs. 12,00,000 × 6/20 = Rs.3,60,00	Rs. 12,00,000 × 2/20 = Rs.1,20,000

 

Calculation of Subsequent Cash inflow, Incremental Cash inflow & Terminal Cash Inflow

Particulars	Year 1(Rs.)	Year 2(Rs.)	Year 3(Rs.)	Year 4(Rs.)
Revenue	2500000	2500000	2500000	2500000
Less: Cash expenses	(11,00,000)	(11,00,000)	(11,00,000)	(11,00,000)
EBDT	14,00,000	14,00,000	14,00,000	14,00,000
Less : Depreciation	2,40,000	4,80,000	3,60,000	1,20,000
EBT	11,60,000	9,20,000	10,40,000	12,80,000
Less: Tax @ 30 %	3,48,000	2,76,000	3,12,000	3,84,000
PAT	8,12,000	6,44,000	7,28,000	8,96,000
Add: Depreciation	2,40,000	4,80,000	3,60,000	1,20,000
Annual cash inflow from new machine	10,52,000	11,24,000	10,88,000	10,16,000
Less: Cash inflow of old asset	(4,92,500)	(4,92,500)	(4,92,500)	(4,92,500)
Incremental cash inflow	559500	631500	595500	523500
Terminal Cash inflow				7,20,000

 Calculation of Cash inflow from old machine

Particulars	Year 1 (Rs.)	Year 2(Rs.)	Year 3(Rs.)	Year 4(Rs.)
Revenue	19,50,000	19,50,000	19,50,000	19,50,000
Less: Cash expenses	(12,00,000)	(12,00,000)	(12,00,000)	(12,00,000)
EBDT	6,50,000	6,50,000	6,50,000	6,50,000
Less : Depreciation	(1,25,000)	(1,25,000)	(1,25,000)	(1,25,000)
EBT	5,25,000	5,25,000	5,25,000	5,25,000
Less: Tax @ 30 %	(1,57,500)	(1,57,500)	(1,57,500)	(1,57,500)
PAT	3,67,500	3,67,500	3,67,500	3,67,500
Add: Depreciation	1,25,000	1,25,000	1,25,000	1,25,000
Annual cash inflow from old machine	4,92,500	4,92,500	4,92,500	4,92,500

 Calculation of terminal cash inflow

In this case there is a capital gain since Rs. 20 % of Rs. 15,00,000 = Rs. 3,00,000 (WDV at the time of disposal as per the question) is less than Rs. 4,00,000 (Salvage value of new asset)

Capital Gain on sale of asset = Scrap/Salvage value of asset – WDV of asset at the time of disposal

= Rs. 4,00,000 - Rs. 3,00,000 = Rs. 1,00,000

Capital gain tax = 30 % of Rs. 1,00,000 = Rs.30,000

Terminal Cash inflow = Salvage value of new machine - Tax on Capital Gain of asset + Working Capital released

= Rs. 4,00,000 - Rs.30,000 + Rs.3,50,000 = Rs. 7,20,000.

Note: While calculating Terminal cash inflow; In case of capital gain, tax amount on gain on sale of asset will be subtracted. In case of capital loss, tax amount on loss on sale of asset will be added as it indicates saving for the company due to appropriation of capital losses with other gains of the company.

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