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Part 2 Estimation of Cash Flow in Capital Budgeting problems with solutions
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.
8. RBL Academy is interested in
assessing the cash flows associated with the replacement of an old machine by a
new machine. The old machine bought few years back has a book value of Rs.
1,20,000 which can be sold for Rs.1,20,000. The salvage value of this machine
is zero after 5 years. It is being depreciated annually at the rate of 25 %
p.a. (written down value method.) The cost of new machine is Rs.5,00,000 and it
will not be required after 5 years. It has a salvage of Rs. 2,00,000. It will
be depreciated annually at the rate of 25 % p.a. (Written down value method.)
The new machine is expected to bring a saving of Rs. 1,40,000 in operating
costs. Investment in working capital would remain unaffected. The tax rate
applicable to the firm is 30 per cent. Find out the relevant cash flow for this
replacement decision. (Ignore Tax on capital gain / loss).
Solution
Initial Cash outflow = Cost of new machine – salvage value
of old machine = Rs. 5,00,000 – Rs. 1,20,000 = Rs. 3,80,000.
Subsequent annual
Cash inflow calculation
|
Particulars |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
|
Saving in cost (EBDT) |
140000 |
140000 |
140000 |
140000 |
140000 |
|
Less: Incremental Depreciation |
(95,000) |
(71,250) |
(53,437) |
(40,078) |
(30,059) |
|
EBT |
45,000 |
68,750 |
86,563 |
99,922 |
109,941 |
|
Less: Incremental Tax @ 30 % |
(13,500) |
(20,625) |
(25,969) |
29,977 |
32,982 |
|
Incremental PAT |
31,500 |
48,125 |
60,594 |
69,946 |
76,959 |
|
Add: Incremental Depreciation |
95,000 |
71,250 |
53,437 |
40,078 |
30,059 |
|
Net Cash inflow |
1,26,500 |
1,19,375 |
1,14,031 |
1,10,023 |
1,07,018 |
|
Terminal cash inflow |
2,00,000 |
Terminal Cash inflow
= Salvage value of new machine = Rs. 2,00,000 (Tax ignored as per the question)
New Machine
Depreciation calculation
|
|
Year 1(Rs.) |
Year 2(Rs.) |
Year 3(Rs.) |
Year 4(Rs.) |
Year 5(Rs.) |
|
WDV |
5,00,000 |
5,00,000 – 1,25,000 = 3,75,000 |
3,75,000 - 93,750 = 2,81,250 |
2,81,250 – 70312.5 = 2,10,937.5 |
2,10,937.5 - 52,734 = 1,58,202 |
|
Depreciation |
25 % of 5,00,000 = 1,25,000 |
25 % of 3,75,000 = 93,750 |
25 % of 2,81,250 = 70,312 |
25 % of 2,10,937 = 52,734 |
25 % of 1,58,202 = 39,551 |
Old Machine
Depreciation calculation
|
|
Year 1(Rs.) |
Year 2(Rs.) |
Year 3(Rs.) |
Year 4(Rs.) |
Year 5(Rs.) |
|
WDV |
1,20,000 |
1,20,000- 30,000= 90,000 |
90,000–22500 = 67500 |
67500 - 16,875= 50,625 |
50,625 - 12,656=37,969 |
|
Depreciation |
25 % of 1,20,000= 30,000 |
25 % of 90,000 = 22,500 |
25 % of 67,500 = 16,875 |
25 % of 50,625= 12,656 |
25 % of 37,969 =9,492 |
Calculation of
incremental Depreciation
|
|
Year 1(Rs.) |
Year 2(Rs.) |
Year 3(Rs.) |
Year 4(Rs.) |
Year 5 (Rs) |
|
Depreciation of new machine |
1,25,000 |
93,750 |
70,312 |
52,734 |
39,551 |
|
Less: Depreciation of old machine |
(30,000) |
(22,500) |
(16,875) |
(12,656) |
(9,492) |
|
Incremental Depreciation |
95,000 |
71,250 |
53,437 |
40,078 |
30,059 |
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