ABC Ltd. operates a fleet of cabs. One of its lot of cabs has completed its useful life of 10 years and has been fully depreciated for accounting…

CA Final · Advanced Financial Management · MTP · November 2026
ABC Ltd. operates a fleet of cabs. One of its lot of cabs has completed its useful life of 10 years and has been fully depreciated for accounting purposes. The management is considering whether to dispose of this lot immediately as junk or retain it for a few more years before disposal, as the prices of the metals used in the manufacture of the cabs are fluctuating significantly. If retained, the company will incur annual storage costs. The expected annual storage costs likely to be incurred for each cab at the end of each year is as follows: Particulars End of Year 1 End of Year 2 End of Year 3 Storage Cost (₹) 90,000 1,05,000 1,19,000 The expected junk value of each cab depends on the expected price per kg of the relevant metal. Each cab is expected to weigh approximately 2,000 kg. The expected selling price per kg of the relevant metal, along with the associated probabilities, for each of the next three years is as follows: Probability Year 1 Year 2 Year 3 0.30 ₹ 60.00 ₹ 50.00 ₹ 35.00 0.50 ₹ 70.00 ₹ 57.50 ₹ 42.00 0.20 ₹ 85.00 ₹ 76.25 ₹ 52.50 The cost of capital of ABC Ltd. is 10%. Required: (i) Suggest the optimal year for disposal of the same of cabs as junk. (ii) Suppose that, due to a significant increase in demand for scrap metal, the estimated junk value at the end of Year 3 is revised upward as follows: Probability Expected Price 0.30 ₹ 132.50 0.50 ₹ 200.00 0.20 ₹ 311.00 Comment whether the disposal decision will change. Note: (i) For the calculation purpose use following PVFs: Year 1 2 3 PVFs @ 10% 0.9091 0.8264 0.7513 (ii) While scrap rate per kg can be considered upto two decimal points, other calculations to be rounded off upto whole numbers.

Suggested Answer and Working Notes:

(i) Working Notes: 1. Calculation of expected selling price of metal per kg for each year: Particulars Year 1 Year 2 Year 3 Probability (0.30) ₹ 60.00 ₹ 50.00 ₹ 35.00 Probability (0.50) ₹ 70.00 ₹ 57.50 ₹ 42.00 Probability (0.20) ₹ 85.00 ₹ 76.25 ₹ 52.50 Expected price per kg ₹ 70.00 ₹ 59.00 ₹ 42.00 2. Calculation of expected junk value of the cab for each year: Particulars Year 1 Year 2 Year 3 Expected price per kg ₹ 70.00 ₹ 59.00 ₹ 42.00 Weight of cab 2,000 kg 2,000 kg 2,000 kg Expected junk value ₹ 1,40,000 ₹ 1,18,000 ₹ 84,000 Let us determine the present value under each disposal alternative as follows: Alternative 1: Disposal at the end of Year 1 Expected cash flow net of Storage Cost at the end of Year 1: ₹ 1,40,000 - ₹ 90,000 = ₹ 50,000 Hence, Net Present Value (NPV) shall be: ₹ 50,000 × 0.9091 = ₹ 45,455 Alternative 2: Disposal at the end of Year 2 Storage costs are incurred for both Years 1 and 2. PV of Storage Cost Incurred = (₹ 90,000 × 0.9091) + (₹ 1,05,000 × 0.8264) = ₹ 81,819 + ₹ 86,772 = ₹ 1,68,591 PV of junk value: ₹ 1,18,000 X 0.8264 = ₹ 97,515 Therefore, net present value is: ₹ 97,515 - ₹ 1,68,591 = - ₹ 71,076 Alternative 3: Disposal at the end of Year 3 PV of storage costs: (₹ 90,000 × 0.9091) + (₹ 1,05,000 × 0.8264) + (₹ 1,19,000 × 0.7513) = ₹ 81,819 + ₹ 86,772 + ₹ 89,405 = ₹ 2,57,996 PV of junk value: ₹ 84,000 × 0.7513 = ₹ 63,109 Therefore, net present value is: ₹ 63,109 - ₹ 2,57,996 = - ₹ 1,94,887 Summary Table Disposal at the end of Net PV Year 1 ₹ 45,455 Year 2 (₹ 71,076) Year 3 (₹ 1,94,887) Decision: Since the highest net present value is ₹ 45,455 when the cabs are disposed of at the end of Year 1. (ii) Under the revised scenario, the Year 3 expected selling price per kg is: (0.30 × ₹ 132.50) + (0.50 × ₹ 200) + (0.20 × ₹ 311) = ₹ 39.75 + ₹ 100 + ₹ 62.20 = ₹ 201.95 per kg Therefore, revised expected junk value per cab: = ₹ 201.95 × 2,000 = ₹ 4,03,900 PV of junk value = ₹ 4,03,900 × 0.7513 = ₹ 3,03,450 PV of storage costs remains. Hence, the revised Year 3 net present value is: ₹ 3,03,450 - ₹ 2,57,996 = ₹ 45,454 Decision: Even after the substantial increase in the expected scrap metal price at the end of Year 3, the management would be indifferent between disposing of the cabs at the end of Year 1 and retaining them until the end of Year 3. However, considering that the additional waiting period of two years is relatively long, it is advisable to dispose of the cabs at the end of Year 1.

Topics: Advanced Capital Budgeting Decisions

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