(Exercise) Cash Flow Estimation
Cash Flow Estimation-Class Exercise CE 0-1 ABC Ltd is considering a capital project about which the following information is available. a. The life of project is expected to be 5 years. b. The investment outlay on the project will be Rs 200 million. This consists of Rs 150 million on plant and machinery and Rs 50 million on net working capital. The entire outlay will be incurred in the beginning. c. At the end of 5 years, fixed assets will fetch a net salvage value of Rs 48 million whereas net working capital will be liquidated at its book value. d. The project is expected to increase the revenues of the firm by Rs 250 million per year. The increase in costs on account of the project is expected to be Rs 100 million per year (This includes all items of cost other than depreciation and tax). The tax rate is 30 percent. e. Plant and machinery will be depreciated at the rate of 25 percent per year as per the written down method. Advise the company on the project assuming cost of capital of the firm as 10 percent CE 0-2 PQR Ltd. –an automobile company- is considering introduction of new model with an estimated life of 5 years. The following are the other details: a. The outlay on the project is Rs 120 crores with a salvage value of Rs. 10 crore b. The project requires an additional investment in NWC of Rs 30 crores. At the end of the project, working capital will be fully recovered at par. c. The capital is depreciated following WDV method at the rate of 20 percent per year d. The project will result in additional sales of Rs 150 crore per year with an additional cost (other than depreciation & taxes ) of Rs 110 crore per year e. However this new bike would take away the sales of an existing model to the tune of Rs. 20 crores per year due to brand switching f. The company is in the 35 percent tax bracket Advise the company on the project, given cost of capital as 10 percent CE 0-3 XYZ Ltd- a soap manufacturer- currently produces and sells 2, 00, 000 units a year at the rate of Rs. 20 a unit. It buys the package material from an outside supplier at a price of Rs. 1.75 per soap. The plant manager believes that it would be cheaper to make this material rather than buy it. Direct production costs are estimated to be Rs. 1. 25 per soap. The necessary machinery would cost Rs. 2, 15, 000. The machine will have an economic life of 5 years and a salvage value of Rs.15, 000. The firm follows straight line method of depreciation. The plant manager estimates that the operation would require an additional working capital of Rs. 30, 000. With these savings in packaging, the company would be in a position to reduce the price of the soap by Rs.0.25 and improve the sales to 2, 25, 000 units a year If the company pays tax at the rate of 35 percent and the opportunity cost of capital is 15 percent, would you support the plant manager’s proposal
Prof. Lokanandha Reddy Irala prepared this exercise intended to be used as the basis for class room discussion rather than to illustrate either effective or ineffective handling of a management situation. © 2005, Irala
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(Exercise) Cash Flow Estimation
Cash Flow Estimation- Practice Exercise PE 0-1 ABC# Ltd is considering a capital project about which the following information is available. a. The life of project is expected to be 5 years. b. The investment outlay on the project will be Rs 225 million. This consists of Rs 175 million on plant and machinery and Rs 50 million on net working capital. The entire outlay will be incurred in the beginning. c. At the end of 5 years, fixed assets will fetch a net salvage value of Rs 50 million whereas net working capital will be liquidated at its book value. d. The project is expected to increase the revenues of the firm by Rs 280 million per year. The increase in costs on account of the project is expected to be Rs 130 million per year (This includes all items of cost other than depreciation and tax). The tax rate is 30 percent. e. Plant and machinery will be depreciated at the rate of 30 percent per year as per the written down method. Advise the company on the project assuming cost of capital of the firm as 12 percent PE 0-2 PQR# Ltd. – an automobile company - is considering introduction of new model with an estimated life of 5 years. The following are the other details: a. The outlay on the project is Rs 150 crores with a salvage value of Rs. 20 crore b. The project requires an additional investment in NWC of Rs 40 crores. At the end of the project, working capital will be fully recovered at par. c. The capital is depreciated following WDV method at the rate of 25 percent per year d. The project will result in additional sales of Rs 120 crore per year with an additional cost (other than depreciation & taxes ) of Rs 80 crore per year e. However this new bike would take away the sales of an existing model to the tune of Rs. 30 crores per year due to brand switching f. The company is in the 35 percent tax bracket Advise the company on the project, given cost of capital as 15 percent PE 0-3 XYZ# Ltd- a soap manufacturer- currently produces and sells 2, 50, 000 units a year at the rate of Rs. 20 a unit. It buys the package material from an outside supplier at a price of Rs. 2.00 per soap. The plant manager believes that it would be cheaper to make this material rather than buy it. Direct production costs are estimated to be Rs. 1. 25 per soap. The necessary machinery would cost Rs. 2, 75, 000. The machine will have an economic life of 5 years and a salvage value of Rs. 25, 000. The firm follows straight line method of depreciation. The plant manager estimates that the operation would require an additional working capital of Rs. 50, 000. With these savings in packaging, the company would be in a position to reduce the price of the soap by Rs.0.25 and improve the sales to 3, 00, 000 units a year If the company pays tax at the rate of 30 percent and the cost of capital is 12 percent, would you support the plant manager’s proposal Page 2 of 2
