Mrigank_Shekhar_Tripathi_B55_C2_RNo39_FM_Assign01

1. Capital Budgeting Decision

An Engineering company is considering the purchase of a new machine for its immediate expansion program
PARTICULARS

MACHINE I (Rs.)

Capital Cost

MACHINE II (Rs.)
600,000

600,000

Cost of Production:
Direct Material
Direct Labour
Factory overheads
Administration Cost
Selling and Distbn. Cost

40,000
50,000
60,000
20,000
10,000

50,000
30,000
50,000
10,000
10,000

Total

180,000

150,000

500,000

400,000

Sales per annum

The economic life of machine I is 4 years, while it is 6 years for the other two, after which the machines I, II
during their full economic life. Total tax to be paid is estimated at 45% of net earnings each year.
a. Calculate the cash flows for all the 3 machines for their respective time periods
b. Determine the NPV and IRR of each project considering WACC as 12%
c. Determine the most profitable investment on the basis of project payback method.

PARTICULARS

Capital Cost (Rs.)

Direct Material (Rs.)

Answer:MACHINE I

600,000

40,000

MACHINE II (Rs.)

600,000

50,000

MACHINE III (Rs.)

600,000

48,000

a) Cash Flow
Year

MACHINE I (Rs.)

MACHINE II (Rs.)

-600,000

-600,000

234,500

178,900

234,500

178,900

234,500

178,900

314,500

178,900

178,900

b) WACC
Year

226,900

12%

112%

PV Factor
0
1
2
3
4
5
6

MACHINE I (Rs.)
1
0.8928571429
0.7971938776
0.7117802478
0.6355180784
0.5674268557
0.5066311212

-600,000
234,500
234,500
234,500
314,500
0
0

NPV

NPV at WACC 12% is highest for Machine III, therefore company should
Year

PV Factor
0
1
2
3
4
5
6

MACHINE I (Rs.)
1
0.8928571429
0.7971938776
0.7117802478
0.6355180784
0.5674268557
0.5066311212

-600,000
234,500
234,500
234,500
314,500
0
0

IRR

23.8%

Internal rate of return is best for Machine III, which is 25.2%, therefore
c) Year

MACHINE I (Rs.)
0
1
2
3
4
5
6

Cum CF
-600,000
234,500
234,500
234,500
314,500
0
0

For MACHINE I
Amount required at the end of 2 year for payback completion=
Earning at the end of 4 year=
Fraction of the year required for Rs. 234500
Pay back period for Machine I

-600,000
-365,500
-131,000
103,500
418,000

For MACHINE II
Amount required at the end of 4 year for payback completion=
Earning at the end of 4 year=
fraction of the year required for Rs. 178900
Pay back period for Machine II

For MACHINE III

Amount required at the end of 3 year for payback completion=
Earning at the end of 4 year=
fraction of the year required for Rs. 198900
Pay back period for Machine II

On the basis of Project payback method, Machine I is most profitable

mediate expansion programme. There are three possible machines at same cost which are suitable for the purpose, the details of which are
MACHINE III (Rs.)
600,000
48,000
36,000
58,000
10,000
10,000
162,000
450,000

which the machines I, II and II are expected to have a scrap value of Rs.80,000; Rs. 48,000 and Rs. 60,000 respectively. Sales are expect
gs each year.

Direct Labour (Rs.)

Factory overheads (Rs.)

Administration Cost (Rs.)

Selling and Distbn. Cost

(Rs.)

50,000

60,000

20,000

10,000

30,000

50,000

10,000

10,000

36,000

58,000

10,000

10,000

MACHINE III (Rs.)

-600,000
198,900
198,900
198,900
198,900
198,900

258,900

DCF

MACHINE II (Rs.)
-600,000
209,375
186,942
166,912
199,870
0
0

-600,000
178,900
178,900
178,900
178,900
178,900
226,900

163,100

DCF

MACHINE III (Rs.)

-600,000
159,732
142,618
127,337
113,694
101,513
114,955

-600,000
198,900
198,900
198,900
198,900
198,900
258,900

159,849

e company should go for machine III

MACHINE II (Rs.)
MACHINE III (Rs.)
-600,000
-600,000
178,900
198,900
178,900
198,900
178,900
198,900
178,900
198,900
178,900
198,900
226,900
258,900

20.7%

25.2%

25.2%, therefore company should go for purchage of Machine III

MACHINE II (Rs.)

Cum CF

-600,000
178,900
178,900
178,900
178,900
178,900
226,900

131000 Rs.
234,500 Rs.
0.5586353945
2.6 Yrs

MACHINE III (Rs.)

-600,000
-421,100
-242,200
-63,300
115,600
178,900
405,800

-600,000
198,900
198,900
198,900
198,900
198,900
258,900

Cum CF
-600,000
-401,100
-202,200
-3,300
195,600
198,900
457,800

63300 Rs.
178,900 Rs.
0.3538289547
3.4 Yrs

3300 Rs.
198,900 Rs.
0.0165912519
3.0 Yrs

most profitable

rpose, the details of which are given below:

respectively. Sales are expected to be at the rates shown for each year

Sales per annum (Rs.)

Yearly
Economic Life (Yrs)
Depeciation
Expenses (Rs.)

Selling price
Yearly Tax Expenses
after
(Rs.)
economic life
(Rs.)

500,000

130,000

85,500

400,000

92,000

71,100

450,000

90,000

89,100

80000
48000
60000

DCF
-600,000
177,589
158,562
141,573
126,405
112,861
131,167

248,157

Mrigank_Shekhar_Tripathi_B55_C2_RNo39_FM_Assign01
2. Cost of Capital

Ford Corporations WACC is 11 percent and its tax rate is 36 percent. Fords pre-tax cost of
ratio is 1.5:1. The risk-free rate is 7 percent and the market risk premium is 8 percent. Wha

Answer:-

WACC=
Tax Rate=
Pre Tax Cost of Debt=
Post tax cost of the Debt=
Risk Free Rate=
Market Risk Premium (ERP)=

11%
36%
10%
6%
7%
8%

Debt/Equity Ratio=
Therefore capital cost mix %
Debt=
Equity=

1.5

WACC (Given)
Debt
Equity (WACC-WACC of Debt)

Returns from Equity =

60%
40%
11%
WACC
Mix
3.84%
7.16%

Risk Free Rate

+
17.90%
7.00%
17.90%
7.00%

Beta for Ford's Equity=

1.36

60%
40%

+
+

ent. Fords pre-tax cost of debt is 10 percent and its debt-equity

premium is 8 percent. What is the beta of Fords equity?

Cost
6.40%
17.90%

(ERP x Beta)
8% X Beta
8% X Beta