Scribd
Upload
2 views

FUNDAMENTAL OF FINANCIAL

FUNDAMENTAL OF FINANCIAL

Uploaded by

Saeed Faisal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
2 views

FUNDAMENTAL OF FINANCIAL

FUNDAMENTAL OF FINANCIAL

Uploaded by

Saeed Faisal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 3

NAME: MUAHMMAD HASNAT RAZA

ID:19003

SUBJECT: FUNDAMENTAL OF FINANCIAL


TECHNIQUES

ASSIGNMENT:02

DATE:20-DEC-2024

step 1: Initial Data Overview

• Cost of machinery: Rs. 40,000

• Life of machinery: 4 years

• Salvage value: Rs. 5,000 (after 4 years)

• Annual cost savings: Rs. 14,000

• WDA rate: 25% on reducing balance

• Corporation tax rate: 33%

• After-tax cost of capital: 8%

• Tax payments are in arrears: Taxes are paid in the year following the transaction.

Step 2: Calculate the Annual Tax Savings from Writing Down Allowances
(WDA)

Each year, the machinery will be depreciated at a rate of 25% on the reducing balance basis. The WDA
will be multiplied by the tax rate (33%) to calculate the tax savings.

• Year 1:
o WDA = 25% × Rs. 40,000 = Rs. 10,000

o Tax savings = Rs. 10,000 × 33% = Rs. 3,300

• Year 2:
o WDA = 25% × Rs. 30,000 (remaining value after Year 1 WDA) = Rs. 7,500

o Tax savings = Rs. 7,500 × 33% = Rs. 2,475

• Year 3:
o WDA = 25% × Rs. 22,500 = Rs. 5,625

o Tax savings = Rs. 5,625 × 33% = Rs. 1,856.25

• Year 4:
o WDA = 25% × Rs. 16,875 = Rs. 4,218.75

o Tax savings = Rs. 4,218.75 × 33% = Rs. 1,392.19

Step 3: Calculate After-Tax Savings

The after-tax savings each year from the cost savings of Rs. 14,000 will be:

After-tax savings=14,000×(1−0.33)=9,380 (each year)\text{After-tax savings} = 14,000 \times (1 - 0.33) =


9,380 \text{ (each year)}After-tax savings=14,000×(1−0.33)=9,380 (each year)

Step 4: Calculate Tax Impact on Sale of Machinery (Year 4)

At the end of Year 4, the machinery will be sold for Rs. 5,000. The book value (WDV) of the machinery at
the end of Year 4 is:

WDV at end of Year 4=16,875−4,218.75=12,656.25\text{WDV at end of Year 4} = 16,875 - 4,218.75 =


12,656.25WDV at end of Year 4=16,875−4,218.75=12,656.25

Since the machinery is sold for Rs. 5,000, a balancing charge arises. This is the difference between the
WDV and the sale price, which will be taxed at 33%.

• Balancing charge = Rs. 12,656.25 - Rs. 5,000 = Rs. 7,656.25

• Tax on balancing charge = Rs. 7,656.25 × 33% = Rs. 2,524.56

The final cash flow in Year 4 will be the after-tax savings, plus the sale proceeds, minus the tax on the
balancing charge.

Final cash flow in Year 4=9,380+1,392.19+5,000−2,524.56=13,247.63\text{Final cash flow in Year 4} =


9,380 + 1,392.19 + 5,000 - 2,524.56 =
13,247.63Final cash flow in Year 4=9,380+1,392.19+5,000−2,524.56=13,247.63

Step 5: Cash Flow Summary

Year Cash Flow (Rs.)

0 -40,000

1 12,680

2 11,855

3 11,236.25

4 13,247.63

Step 6: Calculate NPV


Now, we calculate the NPV using a discount rate of 8%:

NPV=12,680(1+0.08)1+11,855(1+0.08)2+11,236.25(1+0.08)3+13,247.63(1+0.08)4−40,000NPV =
\frac{{12,680}}{{(1 + 0.08)^1}} + \frac{{11,855}}{{(1 + 0.08)^2}} + \frac{{11,236.25}}{{(1 + 0.08)^3}} +
\frac{{13,247.63}}{{(1 + 0.08)^4}} - 40,000NPV=(1+0.08)112,680+(1+0.08)211,855+(1+0.08)311,236.25
+(1+0.08)413,247.63−40,000

Let’s compute this calculation:

NPV=12,6801.08+11,8551.1664+11,236.251.2597+13,247.631.3605−40,000NPV = \frac{{12,680}}{{1.08}}
+ \frac{{11,855}}{{1.1664}} + \frac{{11,236.25}}{{1.2597}} + \frac{{13,247.63}}{{1.3605}} -
40,000NPV=1.0812,680+1.166411,855+1.259711,236.25+1.360513,247.63−40,000
NPV=11,750+10,172.14+8,912.81+9,742.16−40,000NPV = 11,750 + 10,172.14 + 8,912.81 + 9,742.16 -
40,000NPV=11,750+10,172.14+8,912.81+9,742.16−40,000 NPV=40,577.11−40,000=577.11NPV =
40,577.11 - 40,000 = 577.11NPV=40,577.11−40,000=577.11

Conclusion

Since the NPV of the project is positive (Rs. 577.11), the machinery should be purchased as it will add
value to the company.

You might also like