Hemsparsh Private Limited is globally recognized consultancy firm having its presence in various countries across the globe and is currently…

CA Intermediate · Financial Management and Strategic Management · MTP · January 2025
Hemsparsh Private Limited is globally recognized consultancy firm having its presence in various countries across the globe and is currently headquartered at Ahmedabad, India. It plans to commence a new branch in the Australia owing to the untapped opportunities available there in the outsourcing business. The company hired a professional for the preparation of the Project report and the fee paid was - 2,00,000. The company also incurred - 5,00,000 in the form R&D costs. As per the project report, the Company will require an initial fund outlay of 25 crores for buying property & setting up the other infrastructure. It will also require working capital amounting to 5 crore. The company is planning to operate for a very long period of time, however for the sake of simplicity, calculations shall end at the end of the 10th year. The Earnings before tax but after deducting Interest Exp (EBT) estimated would be as follows - YEAR EBT (Amount in ₹) 1 2,00,00,000 2 2,50,00,000 3 4,00,00,000 4 4,75,00,000 5 6,00,00,000 6 6,40,00,000 7 6,15,00,000 8 5,25,00,000 9 3,80,00,000 10 2,90,00,000 The above amounts also include an allocated common cost of 12,50,000. Company will distribute 10% dividends every year on post-tax earnings. Company intends to borrow funds of 3 crores at a post-tax Interest rate of 6.5% in India. As per the tax treaty between India & Australia (Tax Agreement between two nations), first 3 years are tax free and from 4th year 75% of corporate taxes are to be paid in the country where it is headquartered and balance in the other nation. Total Corporate tax rate applicable to the company is 30%. However, tax on capital gains is to be paid at 15%, only in the headquarters. Salvage value for depreciation purpose is estimated at 90,00,000. The assets would be disposed of in the market at 3,50,00,000 at the end. Hemsparsh Private Limited desires a premium of 3% to the current MCLR of 12% (Marginal Cost of Funds based Lending Rate). Assume no other assets in the block. CALCULATE NPV for the project and advise only from Indian law perspective. If the company wishes to recoup its investment within 3.5 years, STATE any two measures that the company shall take.

Suggested Answer and Working Notes:

Calculation of NPV (Amount in crores) Year 1 2 3 4 5 6 7 8 9 10 EBT 2.000 2.500 4.000 4.750 6.000 6.400 6.150 5.250 3.800 2.900 Add: Interest 0.195 0.195 0.195 0.252 0.252 0.252 0.252 0.252 0.252 0.252 Add: Allocated Common Cost 0.125 0.125 0.125 0.125 0.125 0.125 0.125 0.125 0.125 0.125 Project Profit Before Tax 2.320 2.820 4.320 5.127 6.377 6.777 6.527 5.627 4.177 3.277 Less: Tax - - - 1.154 1.435 1.525 1.469 1.266 0.940 0.737 Profit After Tax 2.320 2.820 4.320 3.973 4.942 5.252 5.058 4.361 3.237 2.539 Add: Depreciation 2.410 2.410 2.410 2.410 2.410 2.410 2.410 2.410 2.410 - Cash Inflows 4.730 5.230 6.730 6.383 7.352 7.662 7.468 6.771 5.647 2.539 Add: Release Of Working Capital - - - - - - - - - 5.000 Add: Net Cash Inflow from sale of asset (Net Of Tax) (WN-3) - - - - - - - - - 3.471 Total Cash Inflows 4.730 5.230 6.730 6.383 7.352 7.662 7.468 6.771 5.647 11.010 DF @ 15% 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247 PV Cash Inflow 4.113 3.955 4.425 3.650 3.655 3.312 2.808 2.213 1.605 2.722 TOTAL PV CI = 32.458 Crores (-) TOTAL PVCO = 30.000 Crores (Initial Outlay + Working Capital) NPV = 2.458 Crores ADVISE - Since NPV is positive, company should go for the project. Notes - Allocated common costs are to be excluded from cash inflowsDividend distribution are deemed irrelevant for cash flow analysisDiscounting rate = MCLR + premium = 12 + 3 = 15%Interest exp is to be excluded from the cash inflows as it is already getting covered in the discounting rate aboveProfessional fees paid for project report and R&D costs being sunk costs are irrelevant for decision making WN 1 - Calculation of applicable taxes each year For the first 3 years, tax will be zero and for the next 7 years tax rate applicable would 22.5% (30 x 0.75) as balance tax will be paid in Australia, so it will have no relevance under India perspective calculations. WN - 2 Calculation of interest expense each year Since post tax interest rate is given in the question, firstly it needs to be converted to pre-tax rate. However, for the first 3 years of the project, post-tax and pre-tax rate would be same owing to zero taxes Interest Expense (first 3 years) = 3,00,00,000 X 6.5% = 19,50,000 or 0.195 crores Interest Expense (next 7 years) = 3,00,00,000 x 8.39% = 25,17,000 or 0.2517 crores Pre-tax Interest Rate = Post tax Rate / (1 - India Tax Rate) = 6.5 / (1 - 0.225) = 8.39% WN 3 - CALCULATION OF CAPITAL GAINS INCOME IN YEAR 10 Cost of Asset remaining in the block at the beginning of Year 10 = 3,31,00,000 (2,41,00,000 + 90,00,000) (+) New Asset purchased during the year = 0 (-) Sale Value of the Asset = 3,50,00,000 Capital Gains Income before tax = 19,00,000 (-) Capital Gains tax = 19,00,000 x 15% = 2,85,000 Net Cash Inflow after tax = 3,50,00,000-2,85,000 = 3,47,15,000 B) Current Payback Period = 4 + 1.927/7.352 = 4.262 years Target Payback Period = 3.5 years Some key measures to reduce your Payback period are as follows (Only illustrative): Emphasizing on reduction of operational costsImproving marketing thereby resulting into higher salesIncorporate product-led growth strategiesJudicious efforts in bringing down the overall cost of capital thereby reducing the discounting rate and in turn better Payback period.Leveraging out the presence of the fixed cost

Topics: Part-A: Financial Management

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