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Capital Budgeting cash flow estimation 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 |
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 |
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 |
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.
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 |
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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8. RBL Academy is interested in assessing the cash flows associated with the replacement of an old machine by anew 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 |
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/ trade in value of old asset is
Rs.1,00,000 and book value is Rs. 1,60,000. Hence there is a capital loss of
Rs. 60,000
Capital loss = Book value of asset – salvage value of asset
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. 2,50,000 + Rs. 50,000 – Rs.
1,00,000 - 30 % of (Rs. 1,60,000 – Rs.
1,00,000) = Rs. 1,82,000
Cash inflow in all subsequent years will remain same as
incremental depreciation will remain same in all years. Hence there is no need
to calculate cash inflow for ten years. Cash inflow generated in first year
will be similar to cash inflow in other nine years. In tenth year, terminal
cash inflow will also be generated.
Depreciation on new
machine = Purchase price excluding allowance for trade in + installation
cost – salvage value / estimated life = (Rs. 2,50,000 + Rs. 50,000 – Rs.
50,000) / 10 = Rs. 25,000.
Depreciation on old
machine = (Book value of asset – salvage value) / estimated life
= (Rs. 1,60,000 – Rs. 40,000) / 10 = Rs. 12,000
Incremental
Depreciation = Depreciation on new machine - Depreciation on old machine
= Rs. 25,000 - Rs. 12,000 = Rs. 13,000
Calculation of subsequent cash inflow
|
|
Rs. |
|
Savings in maintenance |
30,000 |
|
Saving in operation of plant |
1,10,000 |
|
EBDT |
1,40,000 |
|
Less: Incremental Depreciation |
(13,000) |
|
EBT |
1,27,000 |
|
Less: Tax @ 30 % |
(38,100) |
|
PAT |
88,900 |
|
Add: Incremental Depreciation |
13,000 |
|
Net annual Cash inflow |
1,01,900 |
|
Terminal cash inflow |
Rs. 10,000 |
Calculation of
Terminal Cash inflow
Terminal cash inflow
= Salvage value of new machine – sacrifice of salvage value of old machine due
to its disposal in the beginning of the year
= Rs. 50,000 – Rs. 40,000 = Rs. 10,000
Note: Since calculation is based
on SLM, no capital gain or loss arises as book value of machine is nil at the
end of tenth year (For more details, refer to Income Tax Act, 1961). In case,
salvage value of old machine is greater than salvage value of new machine then
terminal cash inflow will be negative.
Solution
Cash outflow = Cost of new machine – scrap value of old
machine
= Rs. 2,50,000 – Rs. 60,000 = Rs. 190,000
Depreciation on new
machine = Purchase price– salvage value / estimated life
= (Rs. 2,50,000 – Rs. 50,000) / 4 = Rs. 50,000.
Depreciation on old
machine = (Book value of asset – salvage value) / estimated life
= Rs. 1,60,000 / 4 = Rs. 40,000
Incremental
Depreciation = Depreciation on new machine - Depreciation on old machine
= Rs. 50,000 - Rs. 40,000 = Rs. 10,000
Calculation of subsequent cash inflow
|
|
Rs. |
|
Incremental benefit (EBDT) |
90,000 |
|
Less: Incremental Depreciation |
(10,000) |
|
EBT |
80,000 |
|
Less: Tax @ 30 % |
(24,000) |
|
PAT |
64,000 |
|
Add: Incremental Depreciation |
10,000 |
|
Net annual Cash inflow |
74,000 |
|
Terminal cash inflow |
Rs. 50,000 |
Calculation of Terminal
cash inflow
Terminal cash inflow
= Salvage value of new machine – sacrifice of salvage value of old machine due
to its disposal in the beginning of the year
= Rs. 50,000 – 0 (salvage value of old machine is nil) =
Rs.50,000 .
|
|
Year 1 (Rs.) |
Year 2(Rs.) |
Year 3(Rs.) |
Year 4(Rs.) |
Year 5(Rs.) |
|
Existing Machine |
30,000 |
30,000 |
30,000 |
30,000 |
30,000 |
|
New Machine |
70,000 |
90,000 |
1,00,000 |
90,000 |
1,00,000 |
The company uses Straight Line
Method of depreciation. Tax on income as well as on capital gains/losses is
30%. Calculate the incremental cash flows assuming sale value of existing
machine: (i) Rs. 1,20,000, (ii) Rs. 60,000, (iii)Rs. 90,000 and (iv) Rs. 80,000.
Solution
Calculation of
incremental initial cash outflow in different cases
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
|
|
Case 1 Rs.1,20,000 |
Case 2 Rs.1,25,000 |
Case 3 Rs.90,000 |
Case 4 Rs.80,000 |
|
Cost of new machine including installation cost |
2,50,000 |
2,50,000 |
2,50,000 |
2,50,000 |
|
Less: Scrap value of old machine |
(1,20,000) |
(1,25,000) |
(90,000) |
(80,000) |
|
Add: increase in working capital |
30,000 |
30,000 |
30,000 |
30,000 |
|
±
Tax saving / paid on loss or gain on sale of old asset |
(1,500) |
0 |
(10,500) |
(13,500) |
|
Incremental initial cash outflow |
1,58,500 |
1,55,000 |
1,79,500 |
1,86,500 |
Note – Since, in
Case I, III and IV, there is a capital loss. Hence, tax calculated on capital
loss is subtracted from initial cash outflow. 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.
Capital loss = Book value of
asset – salvage/scrap value of asset
Capital Gain = Salvage/scrap
value of asset –Book value of asset
Depreciation on old machine = cost of old machine /
estimated life
= Rs. 1,75,000 / (5+2) = Rs. 25,000.
Book value of old machine today = Rs. 1,75,000 –
depreciation of 2 years of old machine
= Rs. 1,75,000 – Rs. 50,000 = Rs. 1,25,000
Calculation of tax
paid / saved
|
|
Case 1 Rs.1,20,000 |
Case 2 Rs.1,25,000 |
Case 3 Rs.90,000 |
Case 4 Rs.80,000 |
|
Book value of old machine |
1,25,000 |
1,25,000 |
1,25,000 |
1,25,000 |
|
Less : Scrap value of old machine |
(1,20,000) |
(1,25,000) |
(90,000) |
(80,000) |
|
Capital gain / loss |
5,000 loss |
0 |
35,000 loss |
45,000 loss |
|
Tax @ 30 % on Capital gain / loss |
1,500 |
0 |
10,500 |
13,500 |
|
Since, in Case I, III and IV, there is a capital loss. Hence, tax
calculated on capital loss is subtracted from initial cash outflow. |
||||
Calculation of
subsequent incremental annual cash inflow
|
|
Year 1 (Rs.) |
Year 2 (Rs.) |
Year 3 (Rs.) |
Year 4 (Rs.) |
Year 5 (Rs.) |
|
Cash inflow before depreciation and taxes from new machine |
70,000 |
90,000 |
1,00,000 |
90,000 |
1,00,000 |
|
Less: Cash inflow before depreciation and taxes from old machine |
(30,000) |
(30,000) |
(30,000) |
(30,000) |
(30,000) |
|
Incremental Cash inflow before depreciation and taxes |
40,000 |
60,000 |
70,000 |
60,000 |
70,000 |
|
Less: Incremental depreciation |
(25,000) |
(25,000) |
(25,000) |
(25,000) |
(25,000) |
|
EBT (Earning before tax) |
15,000 |
35,000 |
45,000 |
35,000 |
45,000 |
|
Less: Tax @ 30 % |
(4,500) |
(10,500) |
(13,500) |
(10,500) |
(13,500) |
|
PAT |
10,500 |
24,500 |
31,500 |
24,500 |
31,500 |
|
Add : incremental depreciation |
25,000 |
25,000 |
25,000 |
25,000 |
25,000 |
|
Incremental annual net cash inflow |
35,500 |
49,500 |
56,500 |
49,500 |
56,500 |
|
Terminal cash inflow (Release of working capital at the end of 5th
year) |
|
|
|
|
30,000 |
Calculation of
incremental Depreciation
Depreciation on new machine = cost of machine + installation
cost / estimated life
= Rs. 2,50,000 / 5 = Rs.
50,000
Depreciation on old machine = cost of old machine /
estimated life
= Rs. 1,75,000 / (5+2) = Rs. 25,000
Incremental Depreciation = Depreciation on new machine - Depreciation
on old machine
= Rs. 50,000 – Rs. 25,000 = Rs. 25,000
Solution
Calculation of
subsequent annual cash inflow
|
Particulars |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
|
Savings in annual operating cost |
70,000 |
70,000 |
70,000 |
70,000 |
70,000 |
|
Less: Tax @ 30 % |
(21,000) |
(21,000) |
(21,000) |
(21,000) |
(21,000) |
|
Net Saving |
49,000 |
49,000 |
49,000 |
49,000 |
49,000 |
|
Add: expenditure not required |
1,60,000 |
1,60,000 |
|||
|
Less: new expenditure required |
(2,00,000) |
(2,00,000) |
|||
|
Incremental tax saving |
12,000 |
12,000 |
2,400 |
14,400 |
4,800 |
|
Net Cash inflow |
(1,39,000) |
61,000 |
2,11,400 |
(1,36,600) |
2,13,800 |
Calculation of
Incremental tax saving
Incremental tax saving due to change in expenditure plan =
Tax saving on new expenditure – Tax saving on planned expenditure changed.
|
Particulars |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
|
Depreciation on new expenditure |
40,000 |
40,000 |
40,000 |
80,000 |
80,000 |
|
Tax saving @ 30 % (A) |
12,000 |
12,000 |
12,000 |
24,000 |
24,000 |
|
Depreciation on planned expenditure |
0 |
0 |
32,000 |
32,000 |
64,000 |
|
Tax saving @ 30 % (B) |
0 |
0 |
9,600 |
9,600 |
19,200 |
|
Incremental tax saving (A-B) |
12,000 |
12,000 |
2,400 |
14,400 |
4,800 |
Depreciation on new expenditure incurred in year 1 = Rs.
2,00,000 / 5 = Rs. 40,000
Depreciation on new expenditure incurred in year 4 = Rs.
2,00,000 / 5 = Rs. 40,000
In 4th and 5th year Depreciation
amount will be Rs. 40,000 + Rs. 40,000 = Rs. 80,000 ( expenditure has been
incurred in year 1 and 4 ).
Depreciation on planned expenditure of year 3 = Rs. 1,60,000
/ 5 = Rs. 32,000
Depreciation on planned expenditure of year 5 = Rs. 1,60,000
/ 5 = Rs. 32,000
In 5th year Depreciation amount will be Rs.
32,000 + Rs. 32,000 = Rs. 64,000 (expenditure of year 3 and 5 both should be
considered.)