Links to Financial Management notes: -
Time Value of Money
https://rblacademy.blogspot.com/2021/06/time-value-of-money-formulae-financial.html
https://rblacademy.blogspot.com/2021/06/time-value-of-money-part-i-solved.html
https://rblacademy.blogspot.com/2021/06/time-value-of-money-part-2-solved.html
https://rblacademy.blogspot.com/2021/06/time-value-of-money-part-3-solved.html
https://rblacademy.blogspot.com/2021/05/time-value-of-money-i-financial.html
Leverage Analysis
https://rblacademy.blogspot.com/2021/08/financial-management-notes-leverage.html
Cost of Capital
https://rblacademy.blogspot.com/2021/08/cost-of-capital-solved-problems.html
EBIT – EPS Analysis
https://rblacademy.blogspot.com/2021/08/ebit-eps-analysis-financial-break-even.html
Capital Structure Analysis
https://rblacademy.blogspot.com/2022/02/capital-structure-theories-solved.html
Planning & Designing of Capital Structure
https://rblacademy.blogspot.com/2022/03/planning-designing-of-capital-structure.html
Estimation of Cash Flow in Capital Budgeting
https://rblacademy.blogspot.com/2021/06/part-1-estimation-of-cash-flow-in.html
https://rblacademy.blogspot.com/2021/06/part-2-estimation-of-cash-flow-in.html
https://rblacademy.blogspot.com/2021/06/part-3-estimation-of-cash-flow-in.html
https://rblacademy.blogspot.com/2022/03/estimation-of-cash-flow-in-capital.html
Techniques of Capital Budgeting
https://rblacademy.blogspot.com/2021/05/techniques-of-capital-budgeting.html
https://rblacademy.blogspot.com/2021/05/capital-budgeting-i-httprblacademycom.html
https://rblacademy.blogspot.com/2021/05/financial-management-capital-budgeting.html
https://rblacademy.blogspot.com/2021/06/techniques-of-capital-budgeting-solved_2.html
https://rblacademy.blogspot.com/2021/06/techniques-of-capital-budgeting-solved_14.html
https://rblacademy.blogspot.com/2021/06/techniques-of-capital-budgeting-solved.html
Estimation of Cash Flow in Capital
Budgeting problems with solutions
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.
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.
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.
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
|
9. Vikalpa Ltd is evaluating to
replace a semi manually operated machine with a fully automatic one. The
existing machine purchased 10 years ago, with book value of Rs. 1,60,000 has
remaining life of 10 years. Its Salvage value is Rs. 40,000. The current
machine has maintenance expense of Rs. 30,000. The company has been offered Rs.
1,00,000 for the old machine as a trade-in on the automatic model whose
delivery price (before allowance for trade-in) is 2,50,000. The estimated life
of new machine is 10 years salvage value being Rs.50,000. Installation cost of
new machine will be Rs. 50,000. The new machine will help in saving of Rs.
1,10,000 p.a. in operations of the plant. No Maintenance costs are to be
incurred by company as it will be borne by seller of machine. The tax rate is 30% (applicable to both
revenue income as well as capital gains/losses). Depreciation on both machine
is on the basis of Straight line method throughout the life of both machines..
Find out the relevant cash flows.
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.
10. Vishnu ltd is considering
replacing its old machine costing Rs. 1, 60,000 having a written down value of Rs.
64,000. The remaining economic life of the plant is 4 years with zero salvage
value at the end of 4 years. However, it has current salvage value of Rs. 60,000
if disposed off today. The new machine being considered to replace old machine
is of Rs. 2,50,000 having an economic life of 4 years and salvage value of Rs.
50,000. The new machine, due to its technological superiority, is expected to
contribute additional annual benefit (before depreciation and tax) of Rs. 90,000.
Find out the cash flows associated with this decision. Tax rate is 30%. (Ignore
tax on capital gain or loss).
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 .
11. RBL Academy purchased a machine
two years back at Rs. 1,75,000 has a remaining useful life of 5 years. It is
evaluating to replace the old machine with a new one which will cost Rs. 2,50,000
that includes installation cost of Rs. 10,000 and an increase in working
capital of Rs. 30,000. The expected cash inflows before depreciation and taxes
for both the machines are as follows:
|
|
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
12. RBL Academy Ltd. is
considering an expansion plan. Approval of the plan will provide an opportunity
of reducing the annual operating cost by Rs. 70,000 over next 5 years. However,
it will lead to modification of replacement plans of the company. Consequently,
the expenditure plans of Rs. 1,60,000 p.a. for year 3 and 5 will have to
increase to Rs. 2,00,000 p.a. and reschedule to occur in year 1 and 4. All
other plans will remain unaffected. Find out the relevant cash flows for the
expansion plan in respect of the above for first 5 years given that the tax
rate is 30% and depreciation charged is as per Straight Line method (life 5
years).
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.)
Links to Financial Management notes: -
Time Value of Money
https://rblacademy.blogspot.com/2021/06/time-value-of-money-formulae-financial.html
https://rblacademy.blogspot.com/2021/06/time-value-of-money-part-i-solved.html
https://rblacademy.blogspot.com/2021/06/time-value-of-money-part-2-solved.html
https://rblacademy.blogspot.com/2021/06/time-value-of-money-part-3-solved.html
https://rblacademy.blogspot.com/2021/05/time-value-of-money-i-financial.html
Leverage Analysis
https://rblacademy.blogspot.com/2021/08/financial-management-notes-leverage.html
Cost of Capital
https://rblacademy.blogspot.com/2021/08/cost-of-capital-solved-problems.html
EBIT – EPS Analysis
https://rblacademy.blogspot.com/2021/08/ebit-eps-analysis-financial-break-even.html
Capital Structure Analysis
https://rblacademy.blogspot.com/2022/02/capital-structure-theories-solved.html
Planning & Designing of Capital Structure
https://rblacademy.blogspot.com/2022/03/planning-designing-of-capital-structure.html
Estimation of Cash Flow in Capital Budgeting
https://rblacademy.blogspot.com/2021/06/part-1-estimation-of-cash-flow-in.html
https://rblacademy.blogspot.com/2021/06/part-2-estimation-of-cash-flow-in.html
https://rblacademy.blogspot.com/2021/06/part-3-estimation-of-cash-flow-in.html
https://rblacademy.blogspot.com/2022/03/estimation-of-cash-flow-in-capital.html
Techniques of Capital Budgeting
https://rblacademy.blogspot.com/2021/05/techniques-of-capital-budgeting.html
https://rblacademy.blogspot.com/2021/05/capital-budgeting-i-httprblacademycom.html
https://rblacademy.blogspot.com/2021/05/financial-management-capital-budgeting.html
https://rblacademy.blogspot.com/2021/06/techniques-of-capital-budgeting-solved_2.html
https://rblacademy.blogspot.com/2021/06/techniques-of-capital-budgeting-solved_14.html
https://rblacademy.blogspot.com/2021/06/techniques-of-capital-budgeting-solved.html
