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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 |
|
|
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.
|
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.
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 |
|
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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