Hayati Ahmad

08PPM12S2002 (KSS)
Capital Budgeting (Tutorial 3)

Question:
Solution:

Existing Machine New Machine

Purchase Price RM40,000 Purchase Price RM50,000
Installation Expenses RM2,000
Transportation Expenses RM2,000
Insurance RM4,000
Total Purchase Price RM58,000
Salvage Value - Salvage Value RM15,000
Useful life 10 years Useful life 5 years
Depreciation 40,000/ 10 years Depreciation RM58,000 – RM15,000
5
= RM4,000/year = RM8,600/year
Tax 28%
Book Value (BV) Investment Tax Credit (ITC)
BV = Cost – Accumulated Depreciation ITC = Cost of assets X ITC rate
BV = 40,000 – (40,000/10 x 5yrs) ITC = RM58,000 x 28% x 10%
BV = RM20,000 ITC = RM1,624.00
Tax Savings/Expenses
= Sale of old machine – Book Value
= RM5,000 – RM20,000
Loss on disposal of old machine = (RM15,000)
Tax savings of the loss = RM15,000 x 28%
= RM4,200

i) The Initial Outlay

Cash Outflows: RM
Purchase Price of the new machine 50,000
+ Installation Expenses 2,000
+ Transportation Expenses 2,000
+ Insurance 4,000

Cost of the new machine 58,000

- Cash Inflows:
Cash inflows from the sale of old machine (5,000)
Tax saving on loss from the sale (4,200)
Tax saving on investment (1,624)

Net Initial Outlay 47,176

A ii) Net Cash Flow Over a Project’s Life

Existing Machine New Machine

Maintenance Expenses 4,500 3,500
Waste 4,000 2,000
Salary 20,000 0
Depreciation 4,000 8,600

Profit Cash Flows

(RM) (RM)
Savings:
Reduced Maintenance Expenses 1,000 1,000
Reduced Waste 2,000 2,000
Reduced Salary 20,000 20,000
Total Savings 23,000 23,000
Less: Increased in depreciation (4,600) -
Net Profit Before Tax 18,400 23,000
Less: Taxation (28%) (5,152) (5,152)
Net Cash Flow After Tax 13,248 17,848

A (iii) Terminal cash flows

Salvage Value of new machine = RM100,000

+ Net Working Capital = RM30,000.
Terminal cash flows = RM130,000
B (i) Payback Period

Initial Outlay = RM1,130,000.00

Year Annual after tax CF Accumulated CF

(RM) (RM)
0 (1,130,000)
1 200,000 200,000
2 200,000 400,000
3 200,000 600,000
4 200,000 800,000
5 140,000 940,000
6 275,000
7 275,000
8 275,000

Payback Period = T + IO - ACFT

ACF T+1
= 5 + (RM1,130,000 – RM940,000)
275,000
= 5.69 years

B (ii) Net Present Value (NPV)

Year (T) ACF PVIF 15%, 8 PV

(RM) (RM) (RM)
1 200,000 0.8696 173,920
2 200,000 0.7561 151,220
3 200,000 0.6575 131,500
4 200,000 0.5718 114,360
5 140,000 0.4972 69,608
6 275,000 0.4323 118,882.50
7 275,000 0.3759 103,372.50
8 275,000 0.3269 89,897.50
Total 952,760.50
- IO (1,130,000.00)
NPV -RM177,239.50
C (iii) Internal Rate of Return

Year (T) ACF PVIF 10%, 8 PV

(RM) (RM) (RM)
1 200,000 0.9091 181,820
2 200,000 0.8264 165,280
3 200,000 0.7513 150,260
4 200,000 0.6830 136,600
5 140,000 0.6209 86,926
6 275,000 0.5645 155,237.50
7 275,000 0.5132 141,130
8 275,000 0.4665 128,287.5
Total 1,145,541
- IO 1,130,000
NPV RM15,541

Year (T) ACF PVIF 11%, 8 PV

(RM) (RM) (RM)
1 200,000 0.9009 180,180
2 200,000 0.8116 162,320
3 200,000 0.7312 146,240
4 200,000 0.6587 131,740
5 140,000 0.5935 83,090
6 275,000 0.5346 147,015
7 275,000 0.4817 132,467.50
8 275,000 0.4339 119,322.50
Total 1,102,375
- IO 1,130,000
NPV -RM27,625

r= 15,541

r= 10% NPV = 0 R=11%

15,541 0 -27,625

R= 43,166

IRR = 10% + 15,541 (11%-10%

43,166
= 10% + 3.60%
= 13.60%

c) Reject the project because its net present value is negative (-RM177,239.50) and internal rate
of return is lower than 15%