Assignment-4
Question 1:-A company XYZ Pvt Ltd. have four alternatives to purchase reactors, but due to
financial reasons they can only purchase one reactors. All cash inflows after taxes
(CF) and initial cost are given below in table and they are unequally spread
throughout year, all reactors have same life span of 7 years. If company wants to
recover all its investment within 4 years, then determine which alternative they
should choose to purchase the reactors on the basis of payback period?
[3 marks]
Alternatives
Cash
Flow (CF)
A
B
C
D
Initial cost
Rs.70,000
Rs.12,40,000
Rs.1,80,000
Rs.5,40,000
CF Year 1
Rs.24,000
Rs.47,200
Rs.20,000
Rs.2,04,000
CF Year 2
Rs.24,000
Rs.1,80,000
Rs.17,000
Rs.1,57,000
CF Year 3
Rs.24,000
Rs.73,500
Rs.38,000
Rs.2,50,000
CF Year 4
Rs.24,000
Rs.26,700
Rs.76,000
Rs.75,000
CF Year 5
Rs.24,000
Rs.2,00,000
Rs.27,000
Rs.25,000
CF Year 6
Rs.24,000
Rs.4,50,000
Rs.13,000
Rs.16,000
CF Year 7
Rs.24,000
Rs.73,000
Rs.2,20,000
Rs.0
a) A
b) B
c) C
d) D
Sol. Given:-
Service life of equipment (n) = 7 years
Cut=off year for recovery = 4 years
Initial Cost of equipment’s for alternative:–
IA = Rs.70,000IB = Rs.12,40,000 IC= Rs.1,80,000 ID = Rs.5,40,000
Annual cash inflow after taxes
Cumulative annual cash inflow after taxes
Alternative
(B)
Alternative
(A)
Alternative
(B)
Years
1
Rs.47,200
Rs.24,000
Rs.47,200
2
Rs.1,80,000
Rs.48,000
Rs.2,27,200
3
Rs.73,500
Rs.72,000
Rs.9,62,200
4
Rs.26,700
Rs.96,000
Rs.9,88,900
5
Rs.2,00,000
Rs.1,20,000
Rs.11,88,900
6
Rs.4,50,000
Rs.1,44,000
Rs.16,38,900
7
Rs.73,000
Rs.1,68,000
Rs.17,11,900
As the cost of the equipment according to “A” is Rs.70,000, it’s Payback period will be more
than 2 years as this figure falls between cumulative cash inflows after tax (CF) for the year 2
and 3. Up to the end of 2nd year Rs.48,000 will be recovered for equipment according to “A”.
Balance has to be recovered in 3rd year = Rs.70000 – Rs.48000 = Rs.22000
The cash inflow after tax for the 3rd year is Rs.24000.
Hence, the balance amount Rs.22000 can be recovered = 22000
24000 = 0.916 years
Thus the Payback period of equipment for“A” is 2.916 year (accept because payback period
less than cut-off period).
Similarly, cost of the equipment according to “B” is Rs.12,40,000, it’s Payback period will be
more than 5 years as this figure falls between cumulative cash inflows after tax for the year 5
and 6. Up to the end of 5th year Rs.11,88,900 will be recovered of equipment for “B”.
Balance has to be recovered in 6th year = Rs.12,40,000 – Rs.1188000 = Rs.52000
The cash inflow after tax for the 6th year is Rs.4,50,000.
Hence, the balance amount Rs.52000 can be recovered = 52000
450000 = 0.115 years
Thus the Payback period of equipment for “B”is5.115 year (not accept because payback
period more than cut-off period).
Annual cash inflow after taxes
Cumulative annual cash inflow after taxes
Alternative
(D)
Alternative
(C)
Alternative
(D)
Years
1
Rs.2,04,000
Rs.20,000
Rs.2,04,000
2
Rs.1,57,000
Rs.37,000
Rs.3,61,000
3
Rs.2,50,000
Rs.75,000
Rs.6,11,000
4
Rs.75,000
Rs.1,51,000
Rs.6.86,000
5
Rs.25,000
Rs.1,78,000
Rs.7,11,000
6
Rs.16,000
Rs.1,91,000
Rs.7,27,000
7
Rs.0
Rs.2,13,000
Rs.7,27,000
As the cost of the equipment according to “C” is Rs.1,80,000, it’s Payback period will be more
than 5 years as this figure falls between cumulative cash inflows after tax for the year 5 and 6.
Up to the end of 5th year Rs.1,78,000 will be recovered for equipment according to “C”.
Balance has to be recovered in 6th year = Rs.1,80,000 – Rs.1,78,000 = Rs.2000
The cash inflow after tax for the 6thyear is Rs.13000.
Hence, the balance amount Rs.2000 can be recovered = 2000
13000 = 0.153 years
Thus the Payback period of equipment for “C” is 5.153 year (not accept because payback
period more than cut-off period).
Similarly, cost of the equipment according to “D” is Rs.5,40,000, it’s Payback period will be
more than 2 years as this figure falls between cumulative cash inflows after tax for the year 2
and 3. Up to the end of 2nd year Rs.3,61,00 will be recovered of equipment for “D”.
Balance has to be recovered in 3rd year = Rs.5,40,000 – Rs.3,61,000 = Rs.179000
The cash inflow after tax for the 3rdyear is Rs.2,50,000.
Hence, the balance amount Rs.179000 can be recovered = 179000
250000 = 0.716 years
Thus the Payback period of equipment for “D”is2.716 year (accept because payback period
less than cut-off period).
Question 2:-ABC Company made an initial investment of Rs.2,50,000 on a machine and
expected to get annual cash inflow of Rs.45,000 each year for its whole
operational life of 8 years. Depreciation is allowed on straight line basis. Scrap
value of machine is estimate to be Rs.60,300 at the end of its service life.
Calculate its annual rate of return assuming that all other expenses including
income tax are NIL?
[2 marks]
a) 8.515%
b) 13.88%
c) 9.754%
d) 12.97%
Sol. Given:-
Initial Investment or cost (V)= Rs.2,50,000
Annual cash inflow each year = Rs.45,000
Scrap value (VS)= Rs.60,300
Service life (n) = 8 years