NC Ltd. Is considering purchasing a new machine to increase its production facility. At present, it uses an old machine which can process 5,000…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2024
NC Ltd. Is considering purchasing a new machine to increase its production facility. At present, it uses an old machine which can process 5,000 units of TVs per week. NC could replace it with new machine, which is product specific and can produce 15,000 units per week. New machine cost 100 crores and requires the working capital of 3 crores, which will be released at the end of 5 th year. The new machine is expected to have a salvage value of 20 crores. The company expects demand for TVs to be 10,000 units per week. Each TV sells for 30,000 and has Profit Volume Ratio (PV) of 0.10. The company works for the 56 weeks in the year. Additional fixed costs (excluding depreciation) are estimated to increase by 10 crores. The company is subject to a 40% tax rate and its after-tax cost of capital is 20%. The relevant rate of depreciation is 25% for both taxation and accounts. The company uses the WDV method of depreciation. The existing machine will have no scrap value. You are required to: ADVISE whether the company should replace the old machine. (Decimal may be taken up to 2 units)

Suggested Answer and Working Notes:

Cash inflows after tax (CFAT) Particular ₹ Current production (units per week) 5,000 units New capacity (units per week) 15,000 units Demand (units per week) 10,000 units Increase in sales (units per week) A. 5,000 units Contribution per unit (₹ 30,000 x 0.10) B. 3,000 Increase in contribution A x B x 56 84 crores Less: Additional fixed cost 10 crores Increase in profit 74 crores Less: Tax @ 40% 29.6 crores Profit after tax 44.4 crores Tax shield due to depreciation Year Depreciation (₹ in Crore) Tax Shield (₹ in Crore) PV Factor @20% Total Present Value (₹ in Crore) 1 25.00 10 0.83 8.33 2 18.75 7.5 0.69 5.18 3 14.06 5.62 0.58 3.26 4 10.55 4.22 0.48 2.03 5 7.91 3.16 0.40 1.27 Total 20.07 Tax shield on capital loss = (23.73-20.00) x 30% = 1.12 crores Net Present Value (NPV) Particulars Year Cash Flow (₹ in Crores) PVAF @ 20% Present Value (₹ in Crores) Initial Investment 0 (100) 1 (100) Working capital 0 (3) 1 (3) Profit after tax 1-5 44.4 2.99 132.76 Salvage value 5 20 0.40 8.00 Tax shield on Depreciation 1-5 20.07 Tax shield on capital loss 5 1.12 0.40 0.45 Release of Working Capital 5 3 0.40 1.20 NPV 59.47 The company is advised to replace the old machine since the NPV of the new machine is positive.

Topics: Part-A: Financial Management

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