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(iv) In addition to this advertisement expenditure will have to be incurred as under:

Year 1 2 3-5 6-8

Expenditure (₹) 50,00,000 25,00,000 10,00,000 5,00,000

(v) Income Tax is 25%.

(vi) Straight line method of depreciation is permissible for tax purpose.

(vii) Cost of capital is 10%.

(viii) Assume that loss cannot be carried forward.

Present Value Table

Year 1 2 3 4 5 6 7 8
PVF @ 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

Advise about the project acceptability.

(10 Marks, Exam Nov – 2018)

QUESTION – 18
CK Ltd. is planning to buy a new machine. Details of which are as follows:

Cost of the Machine at the commencement ₹ 2,50,000

Economic Life of the Machine 8 year

Residual Value Nil

Annual Production Capacity of the Machine 1,00,000 units

Estimated Selling Price per unit ₹6

Estimated Variable Cost per unit ₹3

Estimated Annual Fixed Cost ₹ 1,00,000

(Excluding depreciation)

Advertisement Expenses in 1st year in addition of

annual fixed cost ₹ 20,000

Maintenance Expenses in 5th year in addition

of annual fixed cost ₹ 30,000

Cost of Capital 12%

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Ignore Tax. Analyze the above-mentioned proposal using the Net Present Value Method
and advice. P.V. factor @ 12% are as under:

Year 1 2 3 4 5 6 7 8
PV Factor 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404

(5 Mark, (Exam Nov – 2020)

QUESTION – 19
K. K. M. M Hospital is considering purchasing an MRI machine. Presently, the hospital
is outsourcing the work received relating to MRI machine and is earning commission
of ₹ 6,60,000 per annum (net of tax). The following details are given regarding the
machine:

(₹)
Cost of MRI machine 90,00,000
Operating cost per annum (excluding Depreciation) 14,00,000
Expected revenue per annum 45,00,000
Salvage value of the machine (after 5 years) 10,00,000
Expected life of the machine 5 years

Assuming tax rate @ 40%, whether it would be profitable for the hospital to purchase
the machine? Give your RECOMMENDATION under:

(i) Net Present Value Method, and

(ii) Profitability Index Method. PV factors at 10% are given below:

Year 1 2 3 4 5
PV factor 0.909 0.826 0.751 0.683 0.620

(Ans: (i) NPV= -14,08,240 (ii) PI = 0.844, RTP Nov – 2022)

QUESTION – 20
Hindlever Company is considering a new product line to supplement its range of
products. It is anticipated that the new product line will involve cash investments of ₹
7,00,000 at time 0 and ₹ 10,00,000 in year 1. After-tax cash inflows of ₹ 2,50,000 are
expected in year 2, ₹ 3,00,000 in year 3, ₹ 3,50,000 in year 4 and ₹ 4,00,000 each year
thereafter through year 10. Although the product line might be viable even after year
10, the company prefers to be conservative and end all calculations at that time.

(a) If the required rate of return is 15 per cent, COMPUTE net present value of the
project. Is it acceptable?

(b) ANALYSE what would be the case if the required rate of return were 10 per
cent?

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(c) CALCULATE its internal rate of return.

(d) COMPUTE the project‟s payback period.

(Ans. (a) NPV= -1,18,200 (b) NPV= 2,51,450 (c) IRR =13.40% (d) Payback Period= 6
years)

QUESTION – 21
Cello Limited is considering buying a new machine which would have a useful
economic life of five years, a cost of ₹ 1,25,000 and a scrap value of ₹ 30,000, with 80
per cent of the cost being payable at the start of the project and 20 per cent at the end
of the first year. The machine would produce 50,000 units per annum of a new
product with an estimated selling price of ₹ 3 per unit. Direct costs would be ₹ 1.75
per unit and annual fixed costs, including depreciation calculated on a straight- line
basis, would be ₹ 40,000 per annum.

In the first year and the second year, special sales promotion expenditure, not
included in the above costs, would be incurred, amounting to ₹ 10,000 and ₹ 15,000
respectively.

CALCULATE NPV of the project for investment appraisal, assuming that the
company‟s cost of capital is 10 percent.

(Ans: NPV = 31,712)

QUESTION – 22
NavJeevani hospital is considering to purchase a machine for medical projectional
radiography which is priced at ₹ 2,00,000. The projected life of the machine is 8 years
and has an expected salvage value of ₹ 18,000 at the end of 8th year. The annual
operating cost of the machine is ₹ 22,500. It is expected to generate revenues of ₹
1,20,000 per year for eight years. Presently, the hospital is outsourcing the
radiography work to its neighbor Test Center and is earning commission income of ₹
36,000 per annum, net of taxes.

Required:

ANALYSE whether it would be profitable for the hospital to purchase the machine.
Give your recommendation under:

(i) Net Present Value method

(ii) Profitability Index method

Consider tax @30%. PV factors at 10% are given below:

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Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

QUESTION – 23
XYZ Ltd. is planning to introduce a new product with a project life of 8 years. Initial
equipment cost will be ₹ 3.5 crores. Additional equipment costing ₹ 25,00,000 will be
purchased at the end of the third year from the cash inflow of this year. At the end of
8 years, the original equipment will have no resale value, but additional equipment
can be sold for ₹ 2,50,000. A working capital of ₹ 40,00,000 will be needed and it will
be released at the end of eighth year. The project will be financed with sufficient
amount of equity capital.

The sales volumes over eight years have been estimated as follows:

Year 1 2 3 4–5 6–8

Units per year 72,000 1,08,000 2,60,000 2,70,000 1,80,000

A sales price of ₹ 240 per unit is expected and variable expenses will amount to 60% of
sales revenue. Fixed cash operating costs will amount ₹ 36,00,000 per year. The loss
of any year will be set off from the profits of subsequent two years. The company is
subject to 30 per cent tax rate and considers 12 per cent to be an appropriate after-tax
cost of capital for this project. The company follows straight line method of
depreciation.

CALCULATE the net present value of the project and advise the management to take
appropriate decision.

The PV factors at 12% are

Year 1 2 3 4 5 6 7 8
PV Factor 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404

Equivalent NPV & Cash flows

QUESTION – 24
A company is required to choose between two machines A and B. The two machines
are designed differently, but have identical capacity and do exactly the same job.
Machine A costs ₹ 6,00,000 and will last for 3 years. It costs ₹ 1,20,000 per year to
run.

Machine B is an „economy‟ model costing ₹ 4,00,000 but will last only for two years,
and costs ₹ 1,80,000 per year to run. These are real cash flows. The costs are
forecasted in rupees of constant purchasing power. Opportunity cost of capital is 10%.
Which machine company should buy? Ignore tax.

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PVIF0.10, 1 = 0.9091,

PVIF0. 10, 2 = 0.8264,

PVIF0. 10, 3 = 0.7513.

(Ans. EAPVCO = Machine A = 3,61,273.93, Machine B = 4,10,481.13)

QUESTION – 25
A company has to make a choice between two machines X and Y. The two machines
are designed differently, but have identical capacity and do exactly the same job.
Machine „X‟ costs ₹ 5,50,000 and will last for three years. It costs ₹ 1,25,000 per year
to run. Machine „Y‟ is an economy model costing ₹ 4,00,000, but will last for two years
and costs ₹ 1,50,000 per year to run. These are real cash flows. The costs are
forecasted in Rupees of constant purchasing power. Opportunity cost of capital is
12%. Ignore taxes. Which machine company should buy?
t=1 t=2 t=3

PVIF0.12 0.8929 0.7972 0.7118

PVIFA0.12,2 = 1.6901

PVIFA0,12,3 = 2.4019

(Ans. EAPVCO = Machine X = 3,53,985.39, Machine B = 3,86,672.39)

QUESTION – 26
Company UVW has to make a choice between two identical machines, in terms of
Capacity, „A‟ and „B‟. They have been designed differently, but do exactly the same job.
Machine „A‟ costs ₹ 7,50,000 and will last for three years. It costs ₹ 2,00,000 per year
to run.

Machine „B‟ is an economy model costing only ₹ 5,00,000, but will last for only two
years. It costs ₹ 3,00,000 per year to run.

The cash flows of Machine „A‟ and „B‟ are real cash flows. The costs are forecasted in
rupees of constant purchasing power. Ignore taxes. The opportunity cost of capital is
9%.

Required:
Which machine the company UVW should buy?

The present value (PV) factors at 9% are:

Year t1 t2 t3

PVIF0.09.t 0.9174 0.8417 0.7722

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(Ans. EAPVCO, Machine A= 4,96,290, Machine B = 5,84,236)

QUESTION – 27
APZ Limited is considering to select a machine between two machines 'A' and 'B'. The
two machines have identical capacity, do exactly the same job, but designed
differently.

Machine 'A' costs ₹ 8,00,000, having useful life of three years. It costs ₹ 1,30,000 per
year to run.

Machine 'B' is an economy model costing ₹ 6,00,000, having useful life of two years. It
costs ₹ 2,50,000 per year to run.

The cash flows of machine 'A' and 'B' are real cash flows. The costs are forecasted in
rupees of constant purchasing power. Ignore taxes.

The opportunity cost of capital is 10%.

The present value factors at 10% are :

Year t1 t2 t3
PVIF0.10,t 0.9091 0.8264 0.7513
PVIFA0.10,2 = 1.7355
PVIFA0.10,3 = 2.4868

Which machine would you recommend the company to buy?

(Ans. EAPVCO – Machine A = 4,51,699, Machine B = 5,95,722)

QUESTION – 28
A company is faced with the problem of choosing between two mutually exclusive
projects. Project A requires a cash outlay of Rs. 1,00,000 and cash running expenses
of Rs. 35,000 per year. On the other hand, Project B will cost Rs. 1,50,000 and require
cash running expenses of Rs. 20,000 per year. Both the projects have a eight-year life.
Project A has a Rs. 4,000 salvage value and Project B has a Rs. 14,000 salvage value.
The company‟s tax rate is 50% and rate of return is 10%. Assume depreciation on
straight line basis. Which project should be accepted.

QUESTION – 29
The management of a company has two alternative projects under consideration.
Project A requires a capital outlay of Rs. 1,20,000 but Project B needs Rs. 1,80,000.
Both are estimated to provide a cash flow for five years: A – Rs. 40,000 per year and B
– Rs. 58,000 per year. The cost of capital is 10%. Show which of the two projects is
preferable from the viewpoint of
(i) Net Present Value; and

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