Pem

Appraisal of Returns
Ex 1 : New Quarry business
Tower Construction Corp. is taking up a stone quarry for executing a Road cum bridge construction
project. A separate subsidiary unit is going to be established for this purpose. Following details are
gathered.
Project life
Project outlay

5 years
fixed Assets
Current assets

:
:

Rs. 150 Cr
Rs. 30 Cr.

Means of finance

Equity
:
Term Loans
:
Cash credit (C/C limit) :

Rs. 60 Cr.
Rs. 100 Cr.
Rs. 20 cr.

Term loan repayment

Average C/C availed

Interest Rates
Expected yearly sale
Operating costs
Depreciation
Tax rate
At end of 5 years ..
Fixed assets released value
Current assets realized value
Required Rate

4 annual instalments of Rs. 25 Cr. each payable at end of

2ndt to 5th yr.
Rs. 20 Cr (throughout project life)
Term loan : 14 % & Cash credit 16% p.a.
Rs. 200 Cr for all future yrs.
Rs. 140 Cr. per year ( excl. depreciation & Interest costs).
25% by written down method (on all fixed Assets).
35%.

Rs. 50 Cr..(Salvage Value)

Rs. 20 Cr..
20%

Ascertain the Cash flows associated with entire project from owners point of view and long
term funds point of view. ( Ignore tax or tax shield on capital gain or loss )
Ex 2 : Star Power : Identification of Cash Flows
Star Power has been in business of EPC contracting for Transmission lines for over 10 years.
Star was earlier procuring these lines from another manufacturer. Star has decided to
manufacture those lines at its own factory. About 4 acres of its existing factory land is
identified for installing the plant. Star anticipates a substantial savings in costs of
Transmission lines. This new manufacturing project will have a life of 3 years only..
Cost of plant.
Means of finance
Repayment

: Rs. 80 Cr.
: Owners : 40%
: Bank : 60%
: 3 equal yearly instalments.
1

Interest on loan
Salvage value
Savings in Costs
Owners required returns
Depreciation
Tax rate

: 14 % p.a.
: Rs. 20 Cr.
: Rs. 36 Cr p.a.
: 18%.
: 25% (Written down value method)
: 30%.

Additional information:
a)
Companys mechanical Dept. containing permanent employee will be attending to
regular maintenance of the new project. They can find time within their existing
working hours and are expected to spend 20% of his time for the crane. The
proportionate cost of such work for new project is Rs 2.4 cr. pa.
b)

The company had long ago constructed a shed which was not being used for any
productive activity and had almost negligible scrap value. It is going to be used for
some processing activity under new project. Shed was erected at cost of Rs 2 cr. 3
years ago.

c)

The Shed was used for parking some heavy transport vehicles. Now these vehicles will
have to be parked elsewhere for which an amount of Rs. 25 lacs will have to be
incurred towards rent annually.

d)

Recently there was an offer for sublease of 4 acres of land on which the transmission
project is to come up . The offer was Rs. 1.50 Cr. per annum.

Reqd : I) Identify the cash flows associated with the investment in the crane.
ii)
Find out whether the investment is advisable?
iii)
Management anticipates that the savings may come down by 10%, Interest
rate may go upto 16% and Salvage value may go down by 20% . Comment on
the adverse impact on project financial viability

Ex 3 : Choice of Equipment
Cost

Annual O&M

Life in yrs

Modern

75 Lacs

12 lacs

Economy

40 Lacs

20 lacs

Salvage value of the both machineries is negligible.

Cost of capital is 16%.
Reqd : Which machine is preferable?
Ex. 4: (outsource)
A company is considering installing a Fly ash treatment system. It can either buy the system
or hire the system. The system is required for 4 years. The new system costs Rs.1,500,000.
The operating cost are expected to be as follows:
Year Operating Cost (Rs)
1

300,000

360,000

400,000

450,000

The estimated salvage value at the end of Four years is Rs. 300,000. The depreciation rate
applicable is 80% on WDV basis. Tax rate is 35%. Cost of capital is 18 per cent.
The alternative is to hire the system by paying Rs. 7,00,000 per year.
Reqd : Which course of action is more beneficial ?
Ex 5 : BOT project : finding out the upfront bid amount

Project Costs
Upfront payment
to Govt

0
-50

10

16
-3

17
-3

18
-4

19
-4

19
-4

20
-5

21
-5

23
-6

24
-6

25
-7

13

14

14

15

15

16

16

17

17

18

Revenue
O&M Costs
-50

Net cashflows
IRR

26.0%

NPV @ 18%

15.9

Company requires 18% return from this project having concession period of 10 years.
Reqd : How much maximum bid the company can quote ?
3

Ex 6 : Replacement of Equipment
A power generating Company is planning to sell old equipment and buy a new one . In either
case equipment will be used for next 5 years only.
Old

New

Present value / Cost

50 lacs

200 Lacs

Annual O&M

70 lacs

35 lacs

Salvage value

NIL

60 Lacs

Loan

Max 75% of cost

Repayment

5 equal yearly
instalments

Interest rate

14% p.a.

Depreciation on Written Down

Method (WDV) method

10%

10%

Ignore taxes on capital gains. Tax rate 35%. Power Company require return at 18%.
Is it worth going in for new Equipment??
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