SRT Limited manufactures steel rods and is now considering to purchase a new aluminium smelting and moulding plant. This plant will have the cost of…

CA Intermediate · Financial Management and Strategic Management · PYQS · January 2025
SRT Limited manufactures steel rods and is now considering to purchase a new aluminium smelting and moulding plant. This plant will have the cost of 20,00,000 to purchase and install the plant. It has a useful life of 5 years with a residual value of 1,00,000. Production and sales from the new plant are expected to be 1,00,000 units per year. Other estimates are as follows: Selling Price 150 per unit Direct Cost 100 per unit Fixed cost (including depreciation) is 8,00,000 per annum. Marketing and promotion cost not included in the above will be - 1,00,000 and - 1,60,000 for years 1 and 2, respectively. Additionally, investment in debtors and stocks will increase in year 1 by - 1,50,000 and - 2,00,000, respectively. Creditors will also increase by - 1,00,000 in year 1. Thus, debtors, stocks, and creditors will be recouped at the end of the fifth year. The cost of capital is 18%. Corporate tax is 30% and is paid in the year in which profits are made. Depreciation is tax deductible. The company follows straight line method of depreciation. Required: (i) Calculate the Net Present Value and Profitability Index of the project. (ii) Advise SRT Limited whether the plant should be purchased. The PV factors at 18% are: Year 1 2 3 4 5 PV factor 0.847 0.718 0.609 0.516 0.437

Suggested Answer and Working Notes:

Calculation Net Present Value (NPV) Years 1 2 3 4 5 Total Units 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 (I) Sales (150per unit) 1,50,00,000 1,50,00,000 1,50,00,000 1,50,00,000 1,50,00,000 (II) Cost Direct cost (100per unit) 1,00,00,000 1,00,00,000 1,00,00,000 1,00,00,000 1,00,00,000 Marketing cost 1,00,000 1,60,000 - - - Depreciation 3,80,000 3,80,000 3,80,000 3,80,000 3,80,000 Fixed cost 4,20,000 4,20,000 4,20,000 4,20,000 4,20,000 Total cost 1,09,00,000 1,09,60,000 1,08,00,000 1,08,00,000 1,08,00,000 Profit (I - II) 41,00,000 40,40,000 42,00,000 42,00,000 42,00,000 Tax @30% 12,30,000 12,12,000 12,60,000 12,60,000 12,60,000 Profit After tax 28,70,000 28,28,000 29,40,000 29,40,000 29,40,000 Add back depreciation 3,80,000 3,80,000 3,80,000 3,80,000 3,80,000 Cash inflow after tax 32,50,000 32,08,000 33,20,000 33,20,000 33,20,000 Add: WC released - - - - 2,50,000 Add: Residual value of machine - - - - 1,00,000 Net cash inflow after tax 32,50,000 32,08,000 33,20,000 33,20,000 36,70,000 Present value factor 0.847 0.718 0.609 0.516 0.437 Present value cash inflow 27,52,750 23,03,344 20,21,880 17,13,120 16,03,790 1,03,94,884 Less: Initial cash outflow (20,00,000 + 2,50,000) 22,50,000 NPV 81,44,884 Initial Investment = 22,50,000 (assumed working capital invested at start of the year) Profitability Index (PI) = Sum of discounted cash inflows / Initial cash outlay or Total discounted cash outflow (as the case may) = 1,03,94,884 / 22,50,000 = 4.62 Advise: Since the plant has a positive NPV and the Profitability Index is > 1, therefore, it should be purchased. Note: If we assume that working capital increased at end of the first year then cash outflow will be (20,00,000 + 2,11,750 (2,50,000 x 0.847) = 22,11,750, NPV 81,83,134 and Profitability Index will be = 1,03,94,884 / 22,11,750 = 4.70.

Topics: Part-A: Financial Management

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