D and Co.is a company which installs pipes for supply of oxygen in the hospitals as per their specifications. It is planning to invest 40 crore in a…

CA Final · Advanced Financial Management · MTP · May 2026
D and Co.is a company which installs pipes for supply of oxygen in the hospitals as per their specifications. It is planning to invest 40 crore in a new facility to convert vans and trucks into ambulance. Each ambulance will be designed and built according to customer requirements. D and Co. expects ambulance production and sales in the first four years of operation to be as follows: Year 1 2 3 4 Ambulances produced and sold 250 300 450 450 The selling price for an ambulance depends on the van or truck which is converted, the quality of the units installed and the extent of conversion work required. D and Co. has undertaken research into likely sales and costs of different kinds of ambulances which could be selected by customers, as follows: Ambulance type Basic Standard Deluxe Probability of selection 20% 45% 35% Selling price (₹ /unit) 30,00,000 42,00,000 72,00,000 Conversion cost (₹ /unit) 23,00,000 29,00,000 40,00,000 Fixed costs of the production facility are expected to depend on the volume of ambulance production as follows: Production volume (units/year) 200-299 300-399 400-499 Fixed costs (₹ crore/year) 40 50 55 The applicable tax rate for D and Co. is 28% per year, being settled in the year in which it arises. The company can claim tax allowable depreciation on the cost of the investment on a straight-line basis over ten years. D and Co. evaluates investment projects using an after-tax discount rate of 11%. Required: Advise the company on the financial viability of the planned investment for the first four years of operation if tax benefit on unabsorbed depreciation for the remaining period will not available.Advise the company on the financial viability of the planned investment continuing to produce and sell ambulances beyond the first four years if after the fourth year of operation, D and Co. expects to continue to produce and sell 450 ambulances per year for the foreseeable future. Note: (1) Use PV Factors rounded off upto three decimal points. (2) Present all calculation in ₹Crore rounded off upto three decimal points.

Suggested Answer and Working Notes:

Working Notes: Average selling price = (30,00,000 x 0.20) + (42,00,000 x 0.45) + (72,00,000 x 0.35) = 50,10,000 per unit Average conversion cost = (23,00,000 x 0.20) + (29,00,000 x 0.45) + (40,00,000 x 0.35) = 31,65,000 per unit Computation of Sales Income Year 1 2 3 4 Sales volume (units/year) 250 300 450 450 Average selling price (₹ /unit) 50,10,000 50,10,000 50,10,000 50,10,000 Sales income (₹ crore/year) 125.25 150.30 225.45 225.45 Computation of Conversion cost Year 1 2 3 4 Sales volume (units/year) 250 300 450 450 Average conversion cost (₹ /unit) 31,65,000 31,65,000 31,65,000 31,65,000 Conversion cost (₹ crore/year) 79.125 94.950 142.425 142.425 Tax allowable depreciation = 40 crore/10 = 4 crore per year Benefit of tax allowable depreciation = 4 crore x 0.28 = 1.12 crore per year Calculation of NPV over four years Year 1 2 3 4 ₹crore ₹crore ₹crore ₹crore Sales income 125.25 150.30 225.45 225.45 Conversion cost (79.125) (94.95) (142.425) (142.425) Contribution 46.125 55.35 83.025 83.025 Fixed costs (40) (50) (55) (55) Before-tax cash flow 6.125 5.35 28.025 28.025 Tax liability at 28% (1.715) (1.498) (7.847) (7.847) Tax allowable depreciation benefits 1.120 1.120 1.120 1.120 After-tax cash flow 5.53 4.972 21.298 21.298 Discount at 11% 0.901 0.812 0.731 0.659 Present values 4.983 4.037 15.569 14.035 Total present value of Inflows 38.624 Initial investment 40.000 NPV (1.376) Advice: If only the first four years of operation are considered, the NPV of the planned investment is negative and so it would not be financially acceptable. Ignoring tax allowable depreciation, after-tax cash flow from year five onwards will be: 28.025 crore - 7.847 crore = 20.178 crore per year Present value of this cash flow in perpetuity = (₹ 20.178 crore /0.11) x 0.659 = 120.885 crore There would be a further six years of tax benefits from tax allowable depreciation. The present value of these cash flows would be - 1.12 crore x 2.787 = 3.121 crore Increase in NPV of production and sales continuing beyond the first four years would be: 120.885 crore +3.121 crore = 124.006 crore In other words, NPV of the planned investment would be - 122.632 crore (₹ 124.006 crore – 1.376 crore) Advise: If production and sales beyond the first four years are considered, the NPV is strongly positive and so the planned investment is financially acceptable.

Topics: Advanced Capital Budgeting Decisions

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