Part A Capital Budgeting Answer 2022

Part A Capital Budgeting
Answer a:
The after tax cash flows for the company is computed using the profit after tax that
the company generated in 5 years.
Computation of Profit After Tax
Year 1 2 3 4 5
No. of units Sold 2,000 2,200 2,420 2,662 2,928
Selling price per unit 50,000 52,500 55,125 57,881 60,775
Sales revenue
generated 10,00,00,000 11,55,00,000 13,34,02,500 15,40,79,888 17,79,62,270
Less: Costs
Variable Cost 6,00,00,000 6,79,80,000 7,70,21,340 8,72,65,178 9,88,71,447
Fixed Cost 50,00,000 51,00,000 52,02,000 53,06,040 54,12,161
Depreciation 1,80,00,000 1,80,00,000 1,80,00,000 1,80,00,000 1,80,00,000
Profit before Tax 1,70,00,000 2,44,20,000 3,31,79,160 4,35,08,669 5,56,78,662
Tax @30% 51,00,000 73,26,000 99,53,748 1,30,52,601 1,67,03,599
Profit After tax 1,19,00,000 1,70,94,000 2,32,25,412 3,04,56,068 3,89,75,064
Based on the profit after tax, we can compute the after tax cash flows as below:
Computation of After Tax Cash flows
Yea
r
Initial
Investment
Profit After
tax Depreciation Working
Capital
Cash Flow
After Tax
0 -10,00,00,000 -30,00,000
-
10,30,00,000
1 1,19,00,000 1,80,00,000 2,99,00,000
2 1,70,94,000 1,80,00,000 3,50,94,000
3 2,32,25,412 1,80,00,000 4,12,25,412
4 3,04,56,068 1,80,00,000 4,84,56,068
5 3,89,75,064 2,50,00,000 30,00,000 6,69,75,064
Total
12,16,50,54
4 22,16,50,544
Explanation:
1. The deprecation for the company is computed as below:
Computation of Depreciation
Original value of the plant 10,00,00,000
Less: Salvage Value (10%) 1,00,00,000
Cost of the plant 9,00,00,000
Depreciation/ year 1,80,00,000
2. Since, deprecation is a non-cash expense for the company the same is added to
profit after tax for arriving at cash flows after tax. The salvage value of the

plant less taxes @ 30% is received at the end of the project period thus added
back into cash flow computation at the end of year 5.
3. The working capital of $3 million is influxed at the beginning of the project
and released at the end of the project period, thus added back at the end of
year 5.
Computation of Pay back period
For Pay back period
Year Cash Flow
After Tax
Cumulative
Cash Flow
1 2,99,00,000 2,99,00,000
2 3,50,94,000 6,49,94,000
3 4,12,25,412 10,62,19,412
4 4,84,56,068 15,46,75,480
5 6,69,75,064 22,16,50,544
Thus, we see that the cash back happens after year 2 and before year 3. The payback
can be computed as below:
Payback period = Year before full recovery + (unrecovered cost at start of year / cash flow
during the next year)
Payback period = 2+ {(100,000,000 – 64,994,000)/41,225,412)
Payback period = 2 + 0.849
Payback period = 2.85 years
Computation of Net Present Value
Year Cash Flow
After Tax
PV factor
@ 4.5%
Present value of
Cash Flows
0 -10,30,00,000 1.0000 -10,30,00,000
1 2,99,00,000 0.9569 2,86,12,440
2 3,50,94,000 0.9157 3,21,36,627
3 4,12,25,412 0.8763 3,61,25,689
4 4,84,56,068 0.8386 4,06,33,386
5 6,69,75,064 0.8025 5,37,44,210
Net present value 8,82,52,351
The NPV of the project is the difference between the present value of all inflows and
present value of all outflows for the company. Projects’ with positive NPV should be
accepted.
Computation of Profitability Index
Present value of all Inflows (A) 19,12,52,351

Present value of all outflows (B) 10,30,00,000
Thus, PI (A/B) 1.86
Answer b:
To,
The management,
GOGreen Motors.
September 22, 2019
Sub: Recommendation on the new project to produce electric vehicles.
Dear Sir,
In our endeavor to undertake a new project to produce electric vehicles for the
Australian domestic market and international markets, we have conducted a feasibility
study to understand the profitability of the new project. The initial sales of the new
EV’s are targeted at Australian metrolpolitan centers and then we plan to expand into
regional centers over the project period of 5 years.
The new project requires us to manufacture EV’s for which we have identified a
property which was earlier used to build petrol fueled motor vehicles, we can refit the
plant at a minimal cost and save our cost on the land. The project will also require
equipment that will cost us $100 million, with a salvage value of $10 million at the
end of 5 years.
Our recommendation is in favor of accepting the project and go ahead with the
manufacture of EV’s as the project is financially viable and will be able to generate
wealth for our shareholders. We say so as the project will yield us a positive NPV of
$88,252,351 and a Profitability Index of 1.86 which is quite high indicating our cash
inflows from the project will generate profits over the cash outflow in the project.
Further, we would be able to recover our initial investment with 2.85 years in the
project and the last 2 years of the project will only bear profits for us. The project is
financially stable with a steady growth projection in demand of the products and we
would also be able to capture the Chinese market with these EV’s thereby giving us
access to a new market.
Thus, we should definitely go ahead with the project and start manufacturing the all-
new EV’s for the market.