Director
93 Points
Posted on 20 January 2012
You can refer to the below illustration for the your answer:
Zenith Industries Ltd. are thinking of investing in a project costing Rs.. 20 lakhs. The life of the project is 5 years and the estimated salvage value of the project is zero. Straight line method of charging depreciation is followed. The tax rate is 50%. The expected cash flows before tax are as follows:
|
Year
|
Cash flow before tax
|
|
1
|
4
|
|
2
|
6
|
|
3
|
8
|
|
4
|
8
|
|
5
|
10
|
You are required to determine the:
(i) Payback period for the investment,
(ii) Average rate of return on the investment,
(iii) Net present value at 10% cost of capital,
(iv) Benefit-cost ratio.
Solution:
Calculation of Annual Cash Inflow After Tax (Rs. lakhs)
|
Particulars
|
1 year
|
2 year
|
3 year
|
4 year
|
5 year
|
|
Cash inflow before depreciation and tax
Less: Depreciation
|
4
4
|
6
4
|
8
4
|
8
4
|
10
4
|
|
EBT
Less: Tax @ 50%
|
-
-
|
2
1
|
4
2
|
4
2
|
6
3
|
|
EAT
Add: Depreciation
|
-
4
|
1
4
|
2
4
|
2
4
|
3
4
|
|
Cash Inflow After Tax
|
4
|
5
|
6
|
6
|
7
|
(i)Payback Period (Rs. lakhs)
|
Year
|
Cash inflow after tax
|
Cumulative cash inflow after tax
|
|
1
2
3
4
5
|
4
5
6
6
7
|
4
9
15
21
28
|
Rs. 5 lakhs
Payback period = 3 years + --------------- x 12 months = 3 years 10 months
Rs. 6 lakhs
(ii) Average Rate of Return
Average return = Rs.8 lakhs / 5 years = Rs.1.6 lakhs
Average investment = Rs.20 lakhs / 2 = Rs.10 lakhs
1.6
Average rate of return = ------ x 100
10
(iii)Calculation of Net Present Value at 10% Cost of Capital (Rs. lakhs)
|
Year
|
Cash inflow after tax
|
Discount factor @ 20%
|
Present Value
|
|
1
2
3
4
5
|
4
5
6
6
7
|
0.909
0.826
0.751
0.683
0.621
|
3.636
4.130
4.506
4.098
4.347
|
|
P.V. of cash inflows
Less: Initial investment
NPV
|
20.717
20.00
0.717
|
P.V. of cash inflow 20.717
(iv)Benefit-Cost Ratio = ------------------------------ = ----------- = 1.036
P.V. of cash outflow 20
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