PQ Ltd. expects sales of 100 lakhs in the year 1. The same will increase by 20 lakhs per year over the next four years. At the end of 5 years the…

Working Notes: (1) Expected Sales Year Expected Sales 1 100 lakhs 2 120 lakhs 3 140 lakhs 4 160 lakhs 5 180 lakhs (2) Expected Expenses excluding Depreciation Year Exp. 1 40 lakhs 2 48 lakhs 3 56 lakhs 4 64 lakhs 5 72 lakhs (3) Cash Inflow from the Project Let P be the cost of the plant then chargeable depreciation for each year shall be 0.20P. Accordingly, annual cash flow from the project shall be computed as follows: Year Expected Sales lakhs Exp. lakhs Dep. (3) Profit Before Tax Tax @30% Profit After Tax 1 100 40 0.20P 60 - 0.20P 18 - 0.06P 42 - 0.14P 2 120 48 0.20P 72 - 0.20P 21.6 - 0.06P 50.4 - 0.14P 3 140 56 0.20P 84 - 0.20P 25.2 - 0.06P 58.8 - 0.14P 4 160 64 0.20P 96 - 0.20P 28.8 - 0.06P 67.2 - 0.14P 5 180 72 0.20P 108 - 0.20P 32.4 - 0.06P 75.6 - 0.14P Year Profit After Tax Dep. Added Back Cash Inflow 1 42 - 0.14P 0.20P 42 + 0.06P 2 50.40 - 0.14P 0.20P 50.40 + 0.06P 3 58.80 - 0.14P 0.20P 58.80 + 0.06P 4 67.20 - 0.14P 0.20P 67.20 + 0.06P 5 75.60 - 0.14P 0.20P 75.60 + 0.06P Total 294 + 0.30P Since NPV will be Zero the required comes as follows: Sum of Cash Inflows – Plant Cost = 0 294 + 0.30P - P = 0 P = 420 Thus, the required investment to be made in plant shall be 420lakhs. Alternative solution if a discount rate of 10% is applied, though students may solve the question using a rate other than 10%. Working Notes: (1) Expected Sales Year Expected Sales 1 100 lakhs 2 120 lakhs 3 140 lakhs 4 160 lakhs 5 180 lakhs (2) Expected Expenses excluding Depreciation Year Exp. 1 40 lakhs 2 48 lakhs 3 56 lakhs 4 64 lakhs 5 72 lakhs (3) Cash Inflow from the Project Let P be the cost of the plant then chargeable depreciation for each year shall be 0.20P. Accordingly, annual cash flow from the project shall be computed as follows: Year Expected Sales lakhs Exp. lakhs Dep. (3) Profit Before Tax Tax Profit After Tax 1 100 40 0.20P 60 - 0.20P 18 - 0.06P 42 - 0.14P 2 120 48 0.20P 72 - 0.20P 21.6 - 0.06P 50.4 - 0.14P 3 140 56 0.20P 84 - 0.20P 25.2 - 0.06P 58.8 - 0.14P 4 160 64 0.20P 96 - 0.20P 28.8 - 0.06P 67.2 - 0.14P 5 180 72 0.20P 108 - 0.20P 32.4 - 0.06P 75.6 - 0.14P Year Profit After Tax Dep. Added Back Cash Inflow PVF @10% PV of Cash Inflow 1 42 - 0.14P 0.20P 42 + 0.06P 0.909 38.178 + 0.05454P 2 50.40 - 0.14P 0.20P 50.40 + 0.06P 0.826 41.6304 + 0.04956P 3 58.80 - 0.14P 0.20P 58.80 + 0.06P 0.751 44.1588 + 0.04506P 4 67.20 - 0.14P 0.20P 67.20 + 0.06P 0.683 45.8976 + 0.04098P 5 75.60 - 0.14P 0.20P 75.60 + 0.06P 0.621 46.9476 + 0.03726P Total 216.8124 + 0.2274P Since NPV will be Zero the required comes as follows: Sum of Cash Inflows – Plant Cost = 0 216.8124 + 0.2274P - P = 0 P = 280.63 Thus, the required investment to be made in plant shall be - 280.63 lakhs.