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The present value interest factor values at different rates of discount are as under:

Rate of t0 t1 t2 t3 t4 t5 t6
discount
0.15 1.00 0.8696 0.7561 0.6575 0.5718 0.4972 0.4323
0.18 1.00 0.8475 0.7182 0.6086 0.5158 0.4371 0.3704
0.20 1.00 0.8333 0.6944 0.5787 0.4823 0.4019 0.3349
0.24 1.00 0.8065 0.6504 0.5245 0.4230 0.3411 0.2751
0.26 1.00 0.7937 0.6299 0.4999 0.3968 0.3149 0.2499

(Ans. (i) NPV, Project P = 5,376, J = 3,807 (ii) IRR, Project P = 19.73%, J =
25.20% (iii) Reinvestment rate assumption (iv) EANPV, Project P = 1,420.44 , J =
1,667.58)

QUESTION – 38
A firm can make investment in either of the following two projects. The firm
anticipates its cost of capital to be 10% and the net (after tax) cash flows of the
projects for five years are as follows:

(Figures in ₹ „000)
Year 0 1 2 3 4 5
Project-A (500) 85 200 240 220 70
Project-B (500) 480 100 70 30 20

The discount factors are as under:

Year 0 1 2 3 4 5
PVF (10%) 1 0.91 0.83 0.75 0.68 0.62
PVF (20%) 1 0.83 0.69 0.58 0.48 0.41

Required:
(i) Calculate the NPV and IRR of each project.

(ii) State with reasons which project you would recommend.

(iii) Explain the inconsistency in ranking of two projects.

(Ans. (i)NPV- Project A= 1,16,350, Project B = 1,05,100 IRR- Project A = 18.66%,

Project B= 24.10% (ii) Project A due to higher NPV )

(2) REPLACEMENT DECISION

QUESTION – 39
An existing machine in B Ltd. can be sold today for ₹1,00,000 net. The cash flow after
tax(CFAT) for the balance life of 4 years is ₹ 30,000 per annum. At the end of the 4th
year,the existing machine can be sold for ₹20,000 net. A new machine can replace the

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existingmachine at a net cash outflow of ₹ 1,50,000 and will generate annual CFAT of
Rs.46,[Link] scrap value at the end of its useful life will be ₹ 25,000 net. If the
discount rate is10%, decide whether the existing machine should be replaced with a
new machine.

QUESTION – 40
R. Ltd. would like to replace on old, relatively inefficient machine that was purchased
four years ago at a cost of ₹ 1,00,000. The machine had an original expected life of 10
years and a zero estimated salvage value at the end of that period. It is being
depreciated on straight-line basis and now has a book value of ₹ 60,000, The Division
Manager reports that a new machine can be bought out and installed for ₹ 1,30,000,
which over its 6 years life, will expand sales from ₹ 1,00,000 to ₹ 1,20,000 and reduce
the Operating costs (excluding depreciation) from ₹ 70,000 to ₹ 50,000. The new
machine has an estimated economic life of six years after which it will fetch ₹ 10.000
as salvage value. The old machine current market value is ₹ 10,000. Income tax rate is
50% and its cost of capital is 12 percent. Advise the Management whether to replace
the old machinery.

QUESTION – 41
A product is currently being manufactured on a Machine that is fully depreciated for
tax purposes and that has a book value of Rs.10,000. The costs of the product are as
follows:
Unit Cost
Labour, direct ₹ 4.00
Labour, indirect 2.00
Variable Overhead 1.50
Fixed Overhead 2.50
₹ 10.00
In the past year 10,000 units were produced and sold for Rs.18 per unit; The new
machine would cost Rs. 75,000. The projected costs associated with the new machine
are as follows:
Unit Cast
Labour, direct ₹ 2.00
Labour, indirect 3.00
Variable Overhead 1.00
Fixed Overhead 2.25
₹ 8.25
The fixed overhead are exclusive of depreciation of equipment.
The old machine could be sold on the-open market now for Rs.5,000. Ten years from
now it is expected to have a salvage value at Rs.1,000. As regards the new machine it
has a life of ten years and an expected salvage value of Rs.10,000. The current
corporate income tax rate is 0.40 and the capital gain tax rate is 0.25. For tax
purposes the entire cost may be depreciated in ten years. The appropriate after tax

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time discount rate for the company is 0.10. It is expected that future demand of the
product will stay steady at 10,000 units per year.
Required: Should the equipment be acquired?
(Ans. NPV = 14,214)

QUESTION – 42
A company wants to invest in a machinery that would cost ₹ 50,000 at the beginning
of year 1. It is estimated that the net cash inflows from operations will be ₹ 18,000 per
annum for 3 years, if the company opts to service a part of the machine at the end of
year 1 at ₹ 10,000. In such a case, the scrap value at the end of year 3 will be ₹
12,500. However, if the company decides not to service the part, then it will have to be
replaced at the end of year 2 at ₹ 15,400. But in this case, the machine will work for
the 4th year also and get operational cash inflow of ₹ 18,000 for the 4th year. It will
have to be scrapped at the end of year 4 at ₹ 9,000. Assuming cost of capital at 10%
and ignoring taxes, will you recommend the purchase of this machine based on the
net present value of its cash flows?

If the supplier gives a discount of ₹ 5,000 for purchase, what would be your decision?
(The present value factors at the end of years 0, 1, 2, 3, 4, 5 and 6 are respectively 1,
0.9091, 0.8264, 0.7513, 0.6830, 0.6209 and 0.5644).

(Ans. Option 1 Replace in year 1 NPV = -4938, After Discount 62, Option 2
Replace in year 2 NPV= 476, After discount 5476)

QUESTION – 43
MNP Limited is thinking of replacing its existing machine by a new machine which
would cost ₹ 60 lakhs. The company‟s current production is ₹ 80,000 units, and is
expected to increase to 1,00,000 units, if the new machine is bought. The selling price
of the product would remain unchanged at ₹ 200 per unit. The following is the cost of
producing one unit of product using both the existing and new machine:

Unit Cost (₹)

Existing New Difference
Machine Machine
(80,000 units) (1,00,000 units)
Materials 75.0 63.75 (11.25)
Wages & Salaries 51.25 37.50 (13.75)
Supervision 20.0 25.0 5.0
Repairs and Maintenance 11.25 7.50 (3.75)
Power and Fuel 15.50 14.25 (1.25)
Depreciation 0.25 5.0 4.75
Allocated Corporate Overheads 10.0 12.50 2.50
183.25 165.50 (17.75)

Required:

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(i) Estimate net present value of the replacement decision.

(ii) Estimate the internal rate of return of the replacement decision.

(iii) Should Company go ahead with the replacement decision? Suggest.

Year (t) 1 2 3 4 5
PVIF0.15,t 0.8696 0.7561 0.6575 0.5718 0.4972
PVIF0.20,t 0.8333 0.6944 0.5787 0.4823 0.4019
PVIF0.25,t 0.80 0.64 0.512 0.4096 0.3277
PVIF0.30,t 0.7692 0.5917 0.4552 0.3501 0.2693
PVIF0.35,t 0.7407 0.5487 0.4064 0.3011 0.2230

(Ans. (i) NPV = 19,12,866 (ii) IRR = 27.71%)

QUESTION – 44
WX Ltd. has a machine which has been in operation for 3 years. Its remaining
estimated useful life is 8 years with no salvage value in the end. Its current market
value is ₹ 2,00,000. The company is considering a proposal to purchase a new model
of machine to replace the existing machine. The relevant information is as follows:

Existing Machine New Machine

Cost of machine ₹ 3,30,000 ₹ 10,00,000
Estimated life 11 years 8 years
Salvage value Nil ₹ 40,000
Annual output 30,000 units 75,000 units
Selling price per unit ₹ 15 ₹ 15
Annual operating hours 3,000 3,000
Material cost per unit ₹4 ₹4
Labour cost per hour* ₹ 40 ₹ 70
Indirect cash cost per annum ₹ 50,000 ₹ 65,000

The company follow the straight line method of depreciation. The corporate tax rate is
30 per cent and WX Ltd. does not make any investment, if it yields less than 12 per
cent. Present value of annuity of Re. 1 at 12% rate of discount for 8 years is 4.968.
Present value of ₹ 1 at 12% rate of discount, received at the end of 8th year is 0.404.
Ignore capital gain tax.

Advise WX Ltd. whether the existing machine should be replaced or not.

* In the question paper this word was wrongly printed as „unit‟ instead of word „hour‟.
The answer provided here is on the basis of correct word i.e. „Labour cost per hour‟.

(Ans. NPV = 7,06,560 )

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QUESTION – 45
An existing company has a machine which has been in operation for two years, its
estimated remaining useful life is 4 years with no residual value in the end. Its current
market value is ₹ 3 lakhs. The management is considering a proposal to purchase an
improved model of a machine gives increase output. The details are as under:

Particulars Existing Machine New Machine

Purchase Price ₹ 6,00,000 ₹10,00,000
Estimated Life 6 years 4 years
Residual Value 0 0
Annual Operating days 300 300
Operating hours per day 6 6
Selling price per unit ₹10 ₹10
Material cost per unit ₹2 ₹2
Output per hour in units 20 40
Labour cost per hour ₹20 ₹30
Fixed overhead per annum excluding depreciation ₹1,00,000 ₹1,00,000
Working Capital ₹1,00,000 ₹1,00,000
Income-tax rate 30% 30%

Assuming that - cost of capital is 10% and the company uses written down value of
depreciation @ 20% and it has several machines in 20% block.

Advice the management on the Replacement of Machine as per the NPV method.

The discounting factors table given below:

Discounting Factors Year 1 Year 2 Year 3 Year 4

10% 0.909 0.826 0.751 0.683

(Ans: NPV = 56,778.71210, Exam July – 2021)

QUESTION – 46
The General Manager of Merry Ltd. is considering the replacement of five-year-old
equipment. The company has to incur excessive maintenance cost of the equipment.
The equipment has zero written down value. It can be modernized at a cost of ₹
1,40,000 enhancing its economic life to 5 years. The equipment could be sold for ₹
30,000 after 5 years. The modernization would help in material handling and in
reducing labour, maintenance & repairs costs.

The company has another alternative to buy a new machine at a cost of ₹ 3,50,000
with an economic life of 5 years and salvage value of ₹ 60,000. The new machine is
expected to be more efficient in reducing costs of material handling, labour,
maintenance & repairs, etc.

The annual cost are as follows:

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Existing Modernization New Machine

Equipment (₹) (₹) (₹)
Wages & Salaries 45,000 35,500 15,000
Supervision 20,000 10,000 7,000
Maintenance 25,000 5,000 2,500
Power 30,000 20,000 15,000
1,20,000 70,500 39,500

Assuming tax rate of 50% and required rate of return of 10%, should the company
modernize the equipment or buy a new machine?

PV factor at 10% are as follows:

Year 1 2 3 4 5
PV factor 0.909 0.826 0.751 0.683 0.621

(Ans: NPV- Modernization= 14,122.50, New Machine= -50,282.50, RTP May –

2021)

QUESTION – 47
ABC & Co. is considering whether to replace an existing machine or to spend money
on revamping it. ABC & Co. currently pays no taxes. The replacement machine costs
₹ 18,00,000 now and requires maintenance of ₹ 2,00,000 at the end of every year for
eight years. At the end of eight years, it would have a salvage value of ₹ 4,00,000 and
would be sold. The existing machine requires increasing amounts of maintenance each
year and its salvage value fall each year as follows:

Year Maintenance (₹) Salvage (₹)

Present 0 8,00,000
1 2,00,000 5,00,000
2 4,00,000 3,00,000
3 3,00,000 2,00,000
4 8,00,000 0

The opportunity cost of capital for ABC & Co. is 15%.

REQUIRED:

When should the company replace the machine?

The following present value table is given for you:

Year Present value of ₹ 1 at

15% discount rate
1 0.8696
2 0.7561

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3 0.6575
4 0.5718
5 0.4972
6 0.4323
7 0.3759
8 0.3269

(Ans: Replace now= 2,28,008, Replace in one year = -2,36,524, Replace in 2

years= -6,82,013, Replace in 3 years = -11,15,445, Replace in4 years= -
16,55,365, RTP May – 2022)

QUESTION – 48
HMR Ltd. is considering replacing a manually operated old machine with a fully
automatic new machine. The old machine had been fully depreciated for tax purpose
but has a book value of ₹ 2,40,000 on 31st March 2021. The machine has begun
causing problems with breakdowns and it cannot fetch more than ₹ 30,000 if sold in
the market at present. It will have no realizable value after 10 years. The company has
been offered ₹ 1,00,000 for the old machine as a trade in on the new machine which
has a price (before allowance for trade in) of ₹ 4,50,000. The expected life of new
machine is 10 years with salvage value of ₹ 35,000.

Further, the company follows straight line depreciation method but for tax purpose,
written down value method depreciation @ 7.5% is allowed taking that this is the only
machine in the block of assets.

Given below are the expected sales and costs from both old and new machine:

Old machine (₹) New machine (₹)

Sales 8,10,000 8,10,000
Material cost 1,80,000 1,26,250
Labour cost 1,35,000 1,10,000
Variable overhead 56,250 47,500
Fixed overhead 90,000 97,500
Depreciation 24,000 41,500
PBT 3,24,750 3,87,250
Tax @ 30% 97,425 1,16,175
PAT 2,27,325 2,71,075

From the above information, ANALYSE whether the old machine should be replaced or
not if required rate of return is 10%? Ignore capital gain tax.

PV factors @ 10%:

Year 1 2 3 4 5 6 7 8 9 10
PVF 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386

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(Ans: Incremental NPV= 44,612.44, RTP Nov – 2021)

QUESTION – 49
Lockwood Limited wants to replace its old machine with a new automatic machine.
Two models A and B are available at the same cost of ₹ 5 lakhs each. Salvage value of
the old machine is ₹ 1 lakh. The utilities of the existing machine can be used if the
company purchases model A. Additional cost of utilities to be purchased in this case
will be ₹ 1 lakh. If the company purchases B, then all the existing utilities will have to
be replaced with new utilities costing ₹ 2 lakhs. The salvage value of the old utilities
will be ₹ 0.20 lakhs. The earnings after taxation are expected to be:

Year Cash inflows of A Cash inflows of B P.V. Factor @

(₹) (₹) 15%
1 1,00,000 2,00,000 0.870
2 1,50,000 2,10,000 0.756
3 1,80,000 1,80,000 0.658
4 2,00,000 1,70,000 0.572
5 1,70,000 40,000 0.497
Salvage Value at 50,000 60,000
the end of Year 5

The targeted return on capital is 15%. You are required to

(i) COMPUTE, for the two machines separately, net present value, discounted
payback period and desirability factor and

(ii) STATE which of the machines is to be selected?

QUESTION – 50
Alley Pvt. Ltd. is planning to invest in a machinery that would cost ₹ 1,00,000 at the
beginning of year 1. Net cash inflows from operations have been estimated at ₹ 36,000
per annum for 3 years. The company has two options for smooth functioning of the
machinery - one is service, and another is replacement of parts. If the company opts to
service a part of the machinery at the end of year 1 at ₹ 20,000, in such a case, the
scrap value at the end of year 3 will be ₹ 25,000. However, if the company decides not
to service the part, then it will have to be replaced at the end of year 2 at ₹ 30,800,
and in this case, the machinery will work for the 4th year also and get operational
cash inflow of ₹ 36,000 for the 4th year. It will have to be scrapped at the end of year 4
at ₹ 18,000.

Assuming cost of capital at 10% and ignoring taxes, DETERMINE the purchase of this
machinery based on the net present value of its cash flows.

If the supplier gives a discount of ₹ 10,000 for purchase, what would be your decision?

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Note: The PV factors at 10% are:

Year 0 1 2 3 4 5 6
PV Factor 1 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645

QUESTION – 51
Xavly Ltd. has a machine which has been in operation for 3 years. The machine has a
remaining estimated useful life of 5 years with no salvage value in the end. Its current
market value is ₹ 2,00,000. The company is considering a proposal to purchase a new
model of machine to replace the existing machine. The relevant information is as
follows:

Existing Machine New Machine

Cost of machine ₹ 3,30,000 ₹ 10,00,000
Estimated life 8 years 5 years
Salvage value Nil ₹ 40,000
Annual output 30,000 units 75,000 units
Selling price per unit ₹ 15 ₹ 15
Annual operating hours 3,000 3,000
Material cost per unit ₹4 ₹4
Labour cost per hour ₹ 40 ₹ 70
Indirect cash cost per annum ₹ 50,000 ₹ 65,000

The company uses written down value of depreciation @ 20% and it has several other
machines in the block of assets. The Income tax rate is 30 per cent and Xavly Ltd.
does not make any investment, if it yields less than 12 per cent.

ADVISE Xavly Ltd. whether the existing machine should be replaced or not.

PV factors @12%:

Year 1 2 3 4 5
PVF 0.893 0.797 0.712 0.636 0.567

QUESTION – 52
A & Co. is contemplating whether to replace an existing machine or to spend money
on overhauling it. A & Co. currently pays no taxes. The replacement machine costs ₹
90,000 now and requires maintenance of ₹ 10,000 at the end of every year for eight
years. At the end of eight years it would have a salvage value of ₹ 20,000 and would be
sold. The existing machine requires increasing amounts of maintenance each year and
its salvage value falls each year as follows:

Year Maintenance (₹) Salvage (₹)

Present 0 40,000
1 10,000 25,000

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2 20,000 15,000
3 30,000 10,000
4 40,000 0

The opportunity cost of capital for A & Co. is 15%.

REQUIRED:

When should the company replace the machine?

(Note: Present value of an annuity of Re. 1 per period for 8 years at interest rate of
15% : 4.4873; present value of Re. 1 to be received after 8 years at interest rate of 15%
: 0.3269).

(Ans: Replace now= 11,400, Replace in one year = -11,832, Replace in 2 years= --
34,102, Replace in 3 years = -55,799, Replace in4 years= -82,799)

QUESTION – 53
A chemical company is presently paying an outside firm ₹ 1 per gallon to dispose off
the waste resulting from its manufacturing operations. At normal operating capacity,
the waste is about 50,000 gallons per year.

After spending ₹ 60,000 on research, the company discovered that the waste could be
sold for ₹ 10 per gallon if it was processed further. Additional processing would,
however, require an investment of ₹ 6,00,000 in new equipment, which would have an
estimated life of 10 years with no salvage value. Depreciation would be calculated by
straight line method.

Except for the costs incurred in advertising ₹ 20,000 per year, no change in the
present selling and administrative expenses is expected, if the new product is sold.
The details of additional processing costs are as follows:

Variable : ₹ 5 per gallon of waste put into process.

Fixed : (Excluding Depreciation) ₹ 30,000 per year.

There will be no losses in processing, and it is assumed that the total waste processed
in a given year will be sold in the same year. Estimates indicate that 50,000 gallons of
the product could be sold each year.

The management when confronted with the choice of disposing off the waste or
processing it further and selling it, seeks your ADVICE. Which alternative would you
recommend? Assume that the firm's cost of capital is 15% and it pays on an average
50% Tax on its income.

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You should consider Present value of Annuity of ₹ 1 per year @ 15% p.a. for 10 years
as 5.019.

(5) CAPITAL RATIONING

QUESTION – 54
A company has ₹ 1,00,000 available for investment and has identified the following four
investments is which invest.

Project Investment (₹) NPV (₹)

C 40,000 20,000
D 1,00,000 35,000
E 50,000 24,000
F 60,000 18,000

You are required to optimize the returns from a package of projects within the capital
spending limit if

(i) The project are independent of each other and are divisible.

(ii) The projects are not divisible.

(5 Marks)
(Exam Nov – 2019)

QUESTION – 55
Elite Cooker Company is evaluating three investment situations: (1) Produce a new
line of aluminium skillets, (2) Expand its existing cooker line to include several new
sizes, and (3) Develop a new, higher-quality line of cookers. If only the project in
question is undertaken, the expected present values and the amounts of investment
required are:

Project Investment required Present value of Future Cash-

Flows
₹ ₹
1 2,00,000 2,90,000
2 1,15,000 1,85,000
3 2,70,000 4,00,000

If projects 1 and 2 are jointly undertaken, there will be no economies; the investments
required and present values will simply be the sum of the parts. With projects 1 and 3,
economies are possible in investment because one of the machines acquired can be
used in both production processes. The total investment required for projects 1 and 3
combined is ₹ 4,40,000. If projects 2 and 3 are undertaken, there are economies to be
achieved in marketing and producing the products but not in investment. The
expected present value of future cash flows for projects 2 and 3 is ₹ 6,20,000. If all

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