capital budgeting cw fmp (1)

8/13/2019 Capital Budgeting Cw Fmp (1)

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Q 1: FINANCIAL MANAGEMENT AND POLICY: Capital Budgeting

XYZ Co. Ltd is considering the purchase of one of the following machines, whoserelevant data are given below:

Machine X Machine Y

Estimated Life !ears !ears

Capital Cost "s.#$,$$$ "s.#$,$$$Earning %after ta&': Year ( )

*$,$$$+$,$$$*$,$$$

)$,$$$$,$$$+$,$$$

-he compan! follows the straight line method of depreciation the estimated salvagevalue of both the t!pes of machines is /ero.0how the most profitable investment based on %i' pa! bac1 period %ii' net present valueassuming a ($2 cost of capital.

Q 2:3 compan! is considering two mutuall! e&clusive proposals, X and Y.

4roposal X will re5uire the initial cost of "s.(*$, $$$ with no salvage value, and will alsore5uire an increase in the level of inventories and receivables of "s.6$, $$$ over its life.-he pro7ect will generate additional sales of "s.($, $$$ and will re5uire cash e&pensesof "s.*$, $$$ in each of its + !ear life. 8t will be depreciated on straight line method.

4roposal Y will re5uire an initial capital of "s.)$$,$$$ with no salvage, and will bedepreciated on straight line basis. -he earnings before depreciation and ta&es during its +!ear life are:

Year ( Year ) Year Year * Year +"s. $,$$$ "s.6,$$$ "s.9$,$$$ "s.#$,$$$ "s.#),$$$

-he compan! has to pa! corporate income ta& at the rate of *$2, and is evaluatingpro7ects with ($2 as the cost of capital.

%i' hich of the pro7ect is acceptable under the net present value method;%ii' ill it ma1e an! difference to the above decision if profitabilit! inde& is

emplo!ed;

< =o.Your feasibilit! re5uire land which !ou bought at "s.(.) million on >ctober ($, )$$+ and

!ou will pa! in ?ecember )$$+. You plan to construct a building on this land andestimate that * million will be paid in )$$6 and * million will be paid in )$$. E5uipmentwill be re5uired in )$$ and estimated cost for this e5uipment will be ($ million.

4ro7ect also re5uires an initial investment in net wor1ing capital e5ual to ()2 of theestimated sales in the first !ear. -his investment will be made in ?ecember )$$ and thiswor1ing capital will also be re5uired to increase ever! !ear b! ()2 of an! sales increasee&pected during the !ear. -he pro7ect estimated economic life is 6 !ears. 3t that time,the land is e&pected to have a mar1et value of (. million, the building a value of (.$million and the e5uipment a value of ) million.

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Mar1eting department e&pect sales for )$$9 would be )+$$$ units and price set for this!ear is "s. ))$$ per unit. -he production department has estimated that variablemanufacturing costs would total 6+2 of sales value and fi&ed overhead costs, e&cludingdepreciation would be "s.9 million for the first !ear of operation. 0ales prices and fi&edoverhead costs are e&pected to increase b! 62 per !ear.

-a& rate is *$2. 3ssume cash flow will occur at the end of ever! !ear. 3lso assume thatcompan! uses diminishing balance method% rate (+2' for e5uipment and +2 for buildingdepreciation.

Q 4:

3@C Ltd manufactures to!s and other short lived fad items. -he research anddevelopment department has come up with an item that would ma1e a good promotionalgift for office e5uipment dealers. 3s a result of efforts b! the sales personnel, the firm hascommitments for this product.-o produce the 5uantit! demanded, 3@C Ltd will need to bu! additional machiner! and

rent additional space. 8t appears that about )+,$$$ s5uare feet will be needed (),+$$s5uare feet of presentl! unused space, but leased at the rate of "s. per s5uare foot per!ear, is available. -here is another (),+$$ s5uare feet ad7oining the 3@C facilit!available rent of "s.* per s5uare foot.-he e5uipment will be purchased for "s.#$$, $$$. 8t will re5uire "s.$,$$$ inmodifications, "s.6$,$$$ for installation and "s.#$,$$$ for testing. -he e5uipment willhave a salvage value of about "s.(9$, $$$ at the end of the third !ear. =o additionalgeneral overhead costs are e&pected to be incurred.-he estimates of revenues and costs for this product for the three !ears have beendeveloped as follows:

4articulars Year ( Year ) Year 0ales "s.($,$$,$$$ "s.)$,$$,$$$ "s.9,$$,$$$Less Costs:Material, Labor andoverhead incurred

*$$,$$$ +$,$$$ +$,$$$

>verhead allocated *$,$$$ +$,$$$ +,$$$"ent +$,$$$ +$,$$$ +$,$$$?epreciation $$,$$$ $$,$$$ $$,$$$

-otal Costs #$,$$$ (,(+,$$$ +,$$$

Earning before ta&es )($,$$$ 9)+,$$$ 6+,$$$Less ta&es 9*,$$$ $,$$$ )6,$$$

Earning after ta&es ()6,$$$ *#+,$$$ +,$$$

8f the compan! sets a re5uired rate of return of )$2 after ta&es, should this pro7ect beaccepted;

Q :

3 compan! owns a machine which is in current use. 8t was purchased for "s.(6$, $$$and had a pro7ected life of (+ !ears with "s.($, $$$ salvage values. 8t has beendepreciated straight line for + !ears to date, and can be sold for "s.($, $$$. 3 newmachine can be purchased at cost of "s.)6$, $$$. 8t will have a ($ !ears life, salvagevalue of "s.($, $$$, and will be depreciated straight line. 8t is estimated that the new

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machine will reduce labor e&penses b! "s.(+, $$$ per !ear and net wor1ing capitalre5uirement b! "s.)$, $$$. -he income ta& rate of the compan! is *$2 and its re5uiredrate of return is ()2 on investment. ?etermine whether the new machine should bepurchased. -he income statement for the firm using the current machine for the current!ear is as follows:

0ales "s.)$,$$,$$$ Labor "s.$$,$$$ Material +$$,$$$ ?epreciation )$$,$$$ -otal Cost (*$$,$$$ Earning before ta& 6$$,$$$ 8ncome ta& $,$$$ 3fter ta& profit )$,$$$

< 6:

"o!al 8ndustries is considering the replacement of one of its moulding machines. -hee&isting machine is in good operating condition, but is smaller than re5uired if the firm isto e&pand its operations. -he old machine is + !ears old, has a current salvage value of"s.$, $$$ and a remaining depreciable life of ($ !ears. -he machine was originall!purchased for "s.+, $$$ and is being depreciated at "s.+,$$$ per !ear. -he new machinewill cost "s.(+$,$$$ and will be depreciated on a straight line basis over ($ !ears, withno salvage value. -he management anticipates that, with the e&panded operations, therewill be need of an additional net wor1ing capital of "s.$, $$$. -he new machine willallow the firm to e&pand current operations, and thereb! increase annual revenues of"s.*$, $$$ and variable operating costs from "s.)$$,$$$ to "s.)($,$$$. -he compan!Asta& rate is *$2 and its cost of capital is ($2. 0hould the compan! replace its e&istingmachine;

< =o.Bendall Corporation is currentl! using a stamping machine made b! @ristol compan!.-he @ristol machine was purchased + !ears ago and has ($ !ears of depreciable life . -he@ristol machine is being depreciated on a straight line basis toward a /ero salvage value.3nnual depreciation charges are )$,$$$. -he machine has a current mar1et value of (+$,$$$. -he Chicago compan! has recentl! introduced what appears to be asubstantiall! superior stamping machine. 8t carries a purchase price of )*+,$$$ andwould re5uire installation e&penses of +$$$. 8t has a depreciable life of ($ !ears and nosalvage value. -he Chicago machine would reduce scrappage resulting in cost savingsbefore ta&es of *),+$$ annuall!. Machine will be sold at the end of pro7ect life i.e. +!ears e5ual to its boo1 value. -a& rate is *$2 and di!"#unt $ate i! 1%& t# e'aluate()et)e$ "#*pan+ !)#uld $epla"e *a")ine #$ n#t,

capital budgeting cw fmp (1)

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