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Tutorial 8-Cash Flow.doc

The document presents a series of financial analysis questions regarding investment proposals, including cash flow calculations, payback periods, and net present value (NPV) assessments for various projects. It covers scenarios involving new machinery, computer systems, and cost-saving initiatives for a consultancy center, with specific details on costs, revenues, tax implications, and depreciation methods. Each question requires an evaluation of financial viability based on provided cash flows and rates of return.

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4 views

Tutorial 8-Cash Flow.doc

The document presents a series of financial analysis questions regarding investment proposals, including cash flow calculations, payback periods, and net present value (NPV) assessments for various projects. It covers scenarios involving new machinery, computer systems, and cost-saving initiatives for a consultancy center, with specific details on costs, revenues, tax implications, and depreciation methods. Each question requires an evaluation of financial viability based on provided cash flows and rates of return.

Uploaded by

9922103183
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Tutorial 8

Cash Flows

Q.1. A company is considering an investment proposal to install new milling controls at a cost of Rs. 50,000.
The facility has a life expectancy of 5 years and no salvage value. The tax rate is 35 per cent. Assume the
firm uses straight-line depreciation and the same is allowed for tax purposes. The estimated cash flows
before depreciation and tax (CFBT) from the investment proposal are as follows:

Year 1 2 3 4 5
CFBT(Rs.) 10000 10,692 12,769 13,462 20,385

Compute the Pay back period and NPV of the project at 10% discount rate.

Q.2. Modern Enterprises Ltd. is considering the purchase of a new computer system for its R&D division,
which would cost Rs. 35 lakhs. The operation and maintenance costs (excluding depreciation) are expected
to be Rs. 7 lakh per annum. It is estimated that the useful life of the system would be 6 years, at the end of
which the disposal value is expected to be Rs. 1 lakh.
The tangible benefits expected from the system in the form of reduction on design and draftsmanship costs
would be Rs. 12 lakh per annum. The disposal of used drawing office equipment and furniture initially is
anticipated to net Rs. 9 lakh.
As this is a capital expenditure in R&D, the new computer system will be depreciated at 100% rate of
depreciation on written down value basis. The capital gains arising from disposal of used assets may be
considered tax-free. The effective tax rate is 35%. The average cost of capital of the company is 12%.
After appropriate analysis of cash flows, advise the company of the financial viability of the proposal. Ignore
tax on salvage value.

Q.3. Himalaya Ltd. Is considering replacement of its existing machine by a new machine which is expected
to cost Rs. 2,00,000. The new machine will have an economic life of five years and is expected to yield
annual cash revenues of Rs. 2, 70,000 and incur annual cash expenses of Rs. 1,40,000. The estimated
salvage value of the new machine at the end of its economic life is Rs. 50,000.

The existing machine has a book value of Rs. 60,000 and can be sold now for Rs. 60,000.It can also be used
for another five years but is expected to generate annual cash revenues of Rs. 2,20,000 and involve cash
expenses of Rs. 1,60,000 annually. The salvage value of the existing machine after five years is estimated at
Rs. 20,000.

The company is in 50% tax bracket. Both the machines are depreciated at 25% using written down value
method. Cost of capital is 10 %. Calculate NPV and indicate the viability of the replacement proposal.

Q.4 Swastik Ltd. manufacturers of special purpose machine tools, have two divisions which are periodically
assisted by visiting teams of consultants. The management is worried about the steady increase of expenses
in this regard over the years. An analysis of last year’s expenses reveals the:
(Rs.)
Consultants Remuneration 250000
Travel and Conveyance 150000
Accommodation Expenses 600000
Boarding Charges 200000
Special Allowances 50000
Total 1250000
The management estimates accommodation expenses to increase by Rs. 200000 annually. As part of a cost
reduction drive, Swastika Limited is proposing to construct a consultancy centre to take care of the
accommodation requirements of the consultants. This centre will additionally save the company Rs.50000 in
boarding charges and Rs. 200000 in the cost of executive training programs hitherto conducted outside the
company’s premises every year.

The following details are available regarding the construction and maintenance of the new centre:

(a) Land at a cost of Rs. 800000 already owned by the company will be used
(b) Construction cost Rs. 1500000 including special furnishings
(c) Cost of annual maintenance Rs. 150000.
(d) Construction cost will be written off over 5 years being the useful life.

Assuming that the write –off of construction cost as aforesaid will be accepted for tax purposes, that the rate
of tax will be 50% and that the desired rate of return 15 %. You are required to analyze the feasibility of the
proposal and make recommendations.

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