Please solve this problem

Mr. Bean Iron Company is considering to install a machine which cost

Rs.1,00,000. The machine has a life of 5 years, and has no salvage value. The company’s

tax rate is 50 per cent, and no investment allowance is provided. The company uses straight

line depreciation. The estimated cash flows before tax from the proposed investment

proposal is as follows.

Sl.No. Year Cash Flow Before Tax

1. 2006-07 20,000

2. 2007-08 22,000

3. 2008-09 28,000

4. 2009-10 30,000

5. 2010-11 50,000

Compute the following:

a) Pay back period

b) Average rate of return

c) Net-profit value at 10% discount

d) Profitability index

Replies (3)

Pay Back Period  - 4 Yrs.

 

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

How the depreciation 400000 is came in zenith problem

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