BC Ltd. is contemplating on buying a new machine at 70,00,000 with an additional working capital requirement of 10,00,000. The machine is expected…

CA Final · Advanced Financial Management · PYQS · May 2025
BC Ltd. is contemplating on buying a new machine at 70,00,000 with an additional working capital requirement of 10,00,000. The machine is expected to have an economic useful life of 5 years, with no salvage value. The company follows the straight line method of depreciation and same is accepted for tax purposes. The machine is expected to generate an incremental increase in the before tax cash operating income of 25,00,000 (in real terms) per year for a period of 5 years. The relevant tax rate is 35%. Inflation is expected to be 6% per year and the firms cost of capital in real term is 10% per year. Assuming that the working capital requirement will remain unchanged throughout the period, in spite of inflation. Advise the company whether the machine should be purchased or not. Show your NPV calculation in real term. Calculation upto two decimal place. PV Factor at 10% & 6% are as under - PV factor 1 2 3 4 5 At 10% 0.909 0.826 0.751 0.683 0.621 At 6% 0.943 0.890 0.840 0.792 0.747

Suggested Answer and Working Notes:

Working Notes: 1. Cash Outflow (Initial Outlay) = 70,00,000 +10,00,000 = 80,00,000 2. Cash Flow After Tax and Present Value Particulars (₹) Incremental cash operating income 25,00,000 Less: Taxes (0.35) 8,75,000 CFAT 16,25,000 Cum. PV Factor for 5 years at 10% 3.790 Present value 61,58,750 3. PV of tax shield due to Depreciation Tax saving due to Depreciation per year 14,00,000 Tax rate 35% Tax saving per year for five years 4,90,000 PV of tax shield due to depreciation Years Tax saving (Nominal) Inflation Factor at 6% Real Tax Saving PVF @ 10% PV (₹) 1 4,90,000 0.943 4,62,070 0.909 4,20,021.63 2 4,90,000 0.890 4,36,100 0.826 3,60,218.60 3 4,90,000 0.840 4,11,600 0.751 3,09,111.60 4 4,90,000 0.792 3,88,080 0.683 2,65,058.64 5 4,90,000 0.747 3,66,030 0.621 2,27,304.63 Present Value of tax shield due to Depreciation 15,81,715.10 4. PV of Release of Working Capital (₹) Release of Working Capital at the end of 5 th year 10,00,000 Inflation Factor at 6% at the end of 5 th year 0.747 Cash Inflow in real terms 7,47,000 PVF @ 10% at the end of 5 th year 0.621 Present Value of Inflow 4,63,887 Calculation of NPV Particulars Present Value (₹) Initial Outlay (80,00,000) Present Value of CFAT 61,58,750 Present Value tax shield on Dep 15,81,715.10 Present Value Release of Working 4,63,887 2,04,352.10 Recommendation: The Company should purchase the machine as the NPV of real cash flow is positive.

Topics: Advanced Capital Budgeting Decisions

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