Year
|
Profit
before Tax and Depreciation
|
1st year
|
8,50,000
|
2nd year
|
7,00,000
|
3rd year
|
6,50,000
|
4th year
|
6,00,000
|
5th year
|
4,50,000
|
(The policy of the company is to
depreciate fixed assets on straight line basis over the period of the asset.
Salvage value of the machine is expected to be Tk.50,000. Assume a 40% tax rate
and cost of capital of 10%)
Required:
Determine the acceptability of the project on the basis of (i) Payback period;
(ii) ARR; (iii) NPV; (iv) IRR; (v) Profitability Index.
(The present values of Tk1 for five years
at 10% are 0.9091; 0.8264; 0.7513; 0.6830; 0.6209)
Solution:
Depreciation = Cost – Salvage value/No.
of year in lifetime = 25,50,000 – (50,000/5) = 5,00,000.
Total Investment = 25,50,000 (Machine
price) + 1,00,000 (Working capital) = 26,50,000.
Statement
of cash inflow:
Particulars
|
1st
year
|
2nd
year
|
3rd
year
|
4th
year
|
5th
year
|
Profit before Tax & Depreciation
Less Depreciation
|
8,50,000
5,00,000
|
7,00,000
5,00,000
|
6,50,000
5,00,000
|
6,00,000
5,00,000
|
4,50,000
5,00,000
|
Profit before Tax
Less Tax @40%
|
3,50,000
1,40,000
|
2,00,000
80,000
|
1,50,000
60,000
|
1,00,000
40,000
|
(50,000)
-
|
Profit after Tax
Add depreciation
|
2,10,000
5,00,000
|
1,20,000
5,00,000
|
90,000
5,00,000
|
60,000
5,00,000
|
(50,000)
5,00,000
|
Cash before Terminal cash inflow
Add Salvage value at 5th
year
Add working Capital
|
7,10,000
-
-
|
6,20,000
-
-
|
5,90,000
-
-
|
5,60,000
-
-
|
4,50,000
50,000
1,00,000
|
7,10,000
|
6,20,000
|
5,90,000
|
5,60,000
|
6,00,000
|
Required
1: (Pay Back Period (PBP):
Year
|
Cash
inflow
|
Cumulative
cash inflow
|
1
|
7,10,000
|
7,10,000
|
2
|
6,20,000
|
13,30,000
|
3
|
5,90,000
|
19,20,000
|
4
|
5,60,000
|
24,80,000
|
5
|
6,00,000
|
30,80,000
|
PBP
= 4 + (Total investment – 4th year cumulative cash inflow)/5th
year cash inflow
= 4 + (26,50,000 – 24,80,000)/6,00,000 = 4.28
years
Required
2: Average rate of return:
ARR= (Average annual profit / Average
investment)*100
=[{(2,10,000+1,20,000+90,000+60,000-50,000)/5}/(26,50,000+50,000)/2]*100=(86,000/13,50,000)*100
=
6.37%
Required
3: Net Present Value (NPV) calculation:
Year
|
Cash
flow
|
Discount
factor@10%
|
Present
value
|
1
|
7,10,000
|
0.9091
|
6,45,467
|
2
|
6,20,000
|
0.8264
|
5,12,368
|
3
|
5,90,000
|
0.7513
|
4,43,267
|
4
|
5,60,000
|
0.6830
|
3,82,480
|
5
|
6,00,000
|
0.6209
|
3,72,540
|
Present Value of cash
Less, investment
|
=23,56,116
=(26,50,000)
|
||
Net Present Value (NPV)
|
(293884)
|
Required
4: Internal Rate of Return (IRR):
Since the NPV at 10% discounting rate is
negative; Let us take lower discounting rate 5%
Therefore,
Present
Value = {7,10,000/(1+0.05)+(620000)/(1+0.05)
+5,90,000/(1+0.05)
+5,60,000/(1+0.05) +6,00,000/(1+0.05) } –
26,50,000 (total investment)
= (6,76,190.48 + 5,62,358.28 +
5,09,664.18 + 4,60,713.39 + 4,70,115.70) - 26,50,000 (total investment)
= 26,77,488 – 26,50,000 (total
investment)
= 27,488.
IRR= A+C/C-D(B-A)
=5% +27,488/27,488-(-2,93,884)*(10%-5%)
=5% + 27,488/321372 * 5%
=5% +0.0855*5%
=0.05+0.0042 = 0.0542 = 5.42%
|
Here,
A= Lower discounting rate
B= Higher discounting rate
C=NPV of lower discounting rate
D= NPV of higher discounting rate
|
Required 5: Calculation of Profitability
Index (PI)
PI = PV of cash inflow/PV
of investment cost
= 23,56,116/26,50,000 = 0.889 = 0.89
(Approximated)
Ans:
i)
Pay Back Period 4.28 years
ii)
ARR = 6.37%
iii)
NPV = (-2,93,884)
iv)
PI = 0.89
Comments:
Out of 5 years project life, the investment will return within 4.28 years, ARR
is 6.37% which is lower than cost of capital, PI is less than 1 and NPV value
negative, So the project is not acceptable.
No comments:
Post a Comment