Question 1

You are employed as the assistant accountant in your company and you are currently
working on an appraisal of a project to purchase a new machine. The machine will cost
Rs. 55,000 and will have a useful life of three years. You have already estimated the cash
flows from the project and their taxation effect, and the results of your estimates can be
summarized as follows:
Year 1 Year 2 Year 3
Post-tax cash inflow Rs. 18,000 Rs. 29,000 Rs. 31,000

Your company uses a post-tax cost of capital of 8% to appraise all projects of this type.

Required:
a) Calculate the net present value of the proposal to purchase the machine.
b) Calculate the payback period for the investment in the machine
Question 2

ABC Ltd. is planning to introduce a new product.

Costs of test marketing (already spent): Rs.250,000.
Cost of the new machine: Rs.100,000.
Residual value of new machine after 5 years is Rs. 30,000.
The machine will be eligible to claim 25% capital allowances on straight line basis.
Increase in net working capital: Rs.10,000 (only at the beginning of the
project).
Production and sales (in units) by year during 5-year life of the machine: 5,000,
8,000, 12,000, 10,000, 6,000.
Selling price of the product is Rs.20.
Production variable costs are Rs.10 per unit.
This type of investment is subject to a tax rate of 30% paid in the same year

Evaluate the financial viability of the project.

Question 3
Sillicon Valley Plc is considering an investment to produce chips for mobile phones using
one of its existing factories. It is expected that these chips can be sold for 4 years after
which they will be replaced by a completely new technologically advanced chip.

The initial investment required is estimated to be Rs. 30 mn to buy the new plant which
will be depreciated on straight line basis over 4 years. It is also estimated that the pre-tax
salvage value of the plant is Rs. 1 mn at the end of the project. As the new plant is
qualified for a special investment promotion scheme, the company can claim 100%
capital allowance in the first year.

The existing plant in the factory will have to be dismantled at a cost of Rs. 1.4 mn and it
has a net book value of Rs. 250,000. However, there is no scrap sales value of this
existing plant.
The working capital requirement is Rs.6.5 mn at the beginning of the project. Annual
fixed costs of running the factory will be Rs. 4.5 mn per annum. The variable cost of
making one chip is Rs. 1,000 in the first two years. However, due to increasing energy
and direct labour costs, the variable cost per chip is expected to increase to Rs. 1,500 in
the next two years.

The demand for the chip will be 10,000 units in every year. The marketing department
estimates that the selling price per chip will be Rs. 4,000 in the first year and in the
subsequent years it will have to be reduced by Rs. 1,000 in every year.

This type of investment is subject to a special tax rate of 10% which is paid in the same
year.
Required:
Determine whether project is financially feasible, using the NPV technique, if the
required rate of return is 12%.