1.

The directors of Beta Limited are contemplating the purchase of a new machine to replace a machine
which has been in operation in the factory for the last 5 years. Ignoring interest but considering tax at
50% of net earnings, suggest which of the two alternatives should be preferred. The following are the
details:
OLD MACHINE NEW MACHINE
Purchase price ` 40,000 ` 60,000
Estimated life of machine 10 years 10 years
Machine running hours per annum 2,000 2,000
Units per hour 24 36
Wages per running hour 3 5. 25
Power per annum 2,000 4,500
Consumables stores per annum 6,000 7,500
All other charges per annum 8,000 9,000
Materials cost per unit 0.50 0.50
Selling price per unit 1.25 1.25
You may assume that the above information regarding sales and cost of sales will hold good throughout
the economic life of each of the machines. Depreciation has to be charged according to straight-line
method. (cwa old material illustration 1)

2. A company has just installed a machine Model A for the manufacture of a new product at capital cost
of `1,00,000. The annual operating costs are estimated at `50,000 (excluding depreciation) and these
costs are estimated on the basis of an annual volume of 1,00,000 units of production. The fixed costs at
this volume of 1,00,000 units of output will amount to `4,00,000 p.a. The selling price is `5 per unit of
output. The machine has a five year life with no residual value. The company has now come across
another machine called Super Model which is capable of giving, the same volume of production at an
estimated annual operating costs of `30,000 exclusive of depreciation. The fixed costs will however,
remain the same in value. This machine also will have a five year life with no residual value. The
capital cost of this machine is `1,50,000. The company has an offer for the sale of the machine Model A
(which has just been installed) at `50,000 and the cost of removal thereof will amount to `10,000. Ignore
tax. In view of the lower operating cost, the company is desirous of dismantling of the machine Model A
and installing the Super Model Machine. Assume that Model A has not yet started commercial
production and that the time lag in the removal thereof and the installation of the Super Model machine
is not material. The cost of capital is 14% and the P.V. Factors for each of the five years respectively are
0.877, 0.769, 0.675, 0.592 and 0.519. State whether the company should replace Model A machine by
installing the Super Model machine. Will there be any change in your decision if the Model A machine
has not been installed and the company is in the process of consideration of selection of either of the
two models of the machine? Present suitable statement to illustrate your answer.( colin and dury
illustration 6)

3. Techtronics Ltd., an existing company, is considering a new project for manufacture of pocket video
games involving a capital expenditure of `600 lakhs and working capital of `150 lakhs. The capacity of the
plant is for an annual production of 12 lakh units and capacity utilisation during the 6-year working life
of the project is expected to be as indicated below.
Year Capacity utilisation (%)
1 33 1/3 %
2 66 2/3 %
3 90 %
4-6 100 %
The average price per unit of the product is expected to be `200 netting a contribution of 40%. Annual
fixed costs, excluding depreciation, are estimated to be `480 lakhs per annum from the third year
onwards; for the first and second year it would be `240lakhs and `360 lakhs respectively. The average
rate of depreciation for tax purposes is 33 1/3% on the capital assets. No other tax reliefs are
anticipated. The rate of income-tax may be taken at 50%.
At the end of the third year, an additional investment of `100 lakhs would be required for working
capital. The company, without taking into account the effects of financial leverage, has targeted for a
rate of return of 15%.
You are required to indicate whether the proposal is viable, giving your working notes and analysis.
Terminal value for the fixed assets may be taken at 10% and for the current assets at 100%. Calculation
may be rounded off to lakhs of rupees. For the purpose of your calculations, the recent amendments to
tax laws with regard to balancing charge may be ignored. ( cma old book illustration 3)

4. A chemical company is considering replacing an existing machine with one costing `65,000. The
existing machine was originally purchased two years ago for `28,000 and is being depreciated by the
straight line method over its seven-year life period. It can currently be sold for `30,000 with no removal
costs. The new machine would cost `10,000 to install and would be depreciate over five years. The
management believes that the new machine would have a salvage value of `5,000 at the end of year 5.
The management also estimates an increase in net working capital requirement of `10,000 as a result of
expanded operations with the new machine. The firm is taxed at a rate of 55% on normal income and
30% on capital gains. The company’s expected after-tax profits for next 5 years with existing machine
and with new machine are given as follows:
Expected after-tax profits
Year With existing machine (`) With new machine (`)
1 2,00,000 2,16,000
2 1,50,000 1,50,000
3 1,80,000 2,00,000
4 2,10,000 2,40,000
5 2,20,000 2,30,000
a) Calculate the net investment required by the new machine.
b) If the company’s cost of capital is 15%, determine whether the new machine should be purchased.
(cma old book illustration 6)

5. A Company is considering two mutually exclusive projects. Project K will require an initial cash
investment in machinery of ` 2,68,000. It is anticipated that the machinery will have a useful life of ten
years at the end of which its salvage will realise `20,500. The project will also require an additional
investment in cash, Sundry debtors and stock of `40,000. At the end of five years from the
commencement of the project balancing equipment for `45,000 has to be installed to make the unit
workable. The cost of additional machinery will be written off to depreciation over the balance life of
the project. The project is expected to yield a net cash flow (before depreciation) of `1,00,000 annually.
Project R, which is the alternative one under consideration, requires an investment of `3,00,000 in
machinery and as in Project K investment in current assets of `40,000. The residual salvage value of the
machinery at the end of its useful life of ten years is expected to be `25,000. The annual cash inflow
(before depreciation) from the project is worked at `80,000 p.a. for the first five years and `1,80,000 per
annum for the next five years.
Depreciation is written off by the Company on sum-of-the years’ digits method, (i.e., if the life of the
asset is 10 years, then in the ratio of 10, 9, 8 and so on). Income tax rate is 50%. A minimum rate of
return has been calculated at 16%. The present value of ` 1 at interest of 16% p.a. is 0.86, 0.74, 0.64,
0.55, 0.48, 0.41, 0.35, 0.30, 0.26 and 0.23 for years 1 to 10 respectively. Which Project is better?
Assuming no capital gains taxes, calculate the Net Present Value of each Project. (own)

6.. A limited company is considering investing a project requiring a capital outlay of ` 6,00,000. Forecast
for annual income after depreciation but before tax is as follows:
Year (`)
1 3,00,000
2 3,00,000
3 240,000
4 240,000
5 120,000
Depreciation may be taken as 20% on original cost and taxation at 50% of net income. You are required
to evaluate the project according to each of the following methods:
a) Pay-back method
b) Rate of return on original investment method
c) Rate of return on average investment method
d) Discounted cash flow method taking cost of capital as 10%
e) Net present value index method
f) Internal rate of return method.
g) Modified internal rate of return method. (own)

7.. A chemical company is considering replacing an existing machine with one costing 765,000. The
existing machine was originally purchased two years ago for 728,000 and is being depreciated by the
straight line method over its seven-year life period. It can currently be sold for 730,000 with no removal
costs. The new machine would cost 710,000 to install and would be depreciate over five years. The
management believes that the new machine would have a salvage value of 75,000 at the end of year 5.
The management also estimates an increase in net working capital requirement of 710,000 as a result of
expanded operations with the new machine. The firm is taxed at a rate of 55% on normal income and
30% on capital gains. The company’s expected after-tax profits for next 5 years with existing machine
and with new machine are given as follows:
Expected after-tax profits
Year With existing machine With new machine
1 2,00,000 2,16,000
2 1,50,000 1,50,000
3 1,80,000 2,00,000
4 2,10,000 2,40,000
5 2,20,000 2,30,000
(a) Calculate the net investment required by the new machine.
(b) If the company’s cost of capital is 12%, determine whether the new machine should be purchased.
(cma new book illustration 4)