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Profit is not a theoretical superior basis of measurement Cash Flow is considered to be the superior basis of measurement
Is not affected by the Accounting conventions Objective and verifiable
2.
3.
Cash flow from operations Profit before tax + Depreciation & other non-cash items + Interest & other non-operating items - Income tax paid - Increase in Working Capital Cash flow from investing Cash paid to acquire Fixed Asset Cash received for disposing Fixed Asset Cash flow from financing Interest/Dividend paid Capital funds raised
Narain
General expenses
Depreciation
100000
50000 350000
125000
25000
100000
30000 70000
Narain
Economic life
Scrap value Profit before depreciation and tax
7 years
Rs. 30,000 Rs. 5,00,000
Compute cash flows for the relevant period assuming written down method of providing depreciation. Narain
Tax rate
30%
Illustration 1
A company will create a computer facility at the cost of Rs. 2 lac. The annual maintenance cost shall be Rs. 20,000. After 5 years the system will be phased out. The expected scrap value is Rs. 40,000. The project gross cash inflows are expected to be:
1st yr
50,000
2nd yr
80,000
3rd yr
1,00,000
4th yr
80,000
5th yr
60,000
Compute the cash flows for the project if tax rate is 30% and depreciation is provided at 60% WDV. Narain
Illustration 2
A firm is using a two year old machine that was purchased for Rs. 70,000. The remaining life is 5 years. Depreciation rate is 40%. Firm is considering its replacement with a new machine costing Rs. 1,40,000 which would be used for 5 years. The installation charges will be Rs. 10,000. The increase in the working capital requirement will be Rs. 20,000 as a result of using the new machine. The firm is subject to income tax rate of 35% and capital gains tax rate of 30%. Determine the initial cash flow if salvage value of existing machine is (a) 80,000 (b) 60,000 (c) 50,000 (d) 20,000.
Narain
Illustration 3
A machine has a book value of Rs. 90,000. and remaining life of 5 years. It is depreciable @ 20%. Its present salvage value is its book value but nil after 5 years. It can be replaced with a new machine worth Rs. 4,00,000. It will have a salvage value of Rs. 2,50,000 after 5 years. The new machine will save Rs. 1,00,000 p.a. in manufacturing costs. It will depreciate @ 33.33%. The tax rate is 35%. Determine the post tax incremental cash flow. Narain
Exercise
A machine purchased for Rs. 96,000 has a book value of Rs. 24,000 and remaining life of 4 years. It is depreciable @ 50%. Its present salvage value is Rs. 20,000 but nil after 4 years. It can be replaced with a new machine worth Rs. 1,30,000. It will have a salvage value of Rs. 8,000 after 4 years. The new machine will save Rs. 60,000 in manufacturing costs. It will depreciate @ 40%. The tax rate is 35%. Determine the post tax incremental cash flow. Narain
Illustration
Find incremental CFAT from the following information:
Purchase price of the new asset
Installation costs Increase in working capital in year zero Scrap value of the new asset after 4 years Annual revenues from new asset
10,00,000
2,00,000 2,50,000 3,50,000 21,50,000
9,50,000
4,00,000 5,00,000 19,25,000 11,25,000
Planning period
Depreciation on new asset Depreciation on old asset Tax rate
4 years
20% 25% 30%
Exercise
A company is considering to install a machine costing Rs. 5,00,000 with an additional investment of Rs. 1,50,000 for its installation. The salvage value at the end of year 10 is estimated at Rs. 2,50,000. The machine is estimated to generate a sales revenue of Rs. 20,00,000 in the first year and the sales are expected to grow at 5% p.a. for the remaining life of the machine. The profit after tax is expected at 10% of the sales while the working capital requirement are expected to be 5% of the sales. Compute the cash flows assuming SLM depreciation and additional working capital is required at the beginning of each year and is fully salvageable.
Solution
Initial investment outlay Rs. 7,50,000 First Year CFAT Rs. 2,35,000 Second Year CFAT Rs. 2,44,750 Third Year CFAT Rs. 2,54,987 Fourth Year CFAT Rs. 2,65,737 Fifth Year CFAT Rs. 2,77,024 Sixth Year CFAT Rs. 2,88,875 Seventh Year CFAT Rs. 3,01,319 Eighth Year CFAT Rs. 3,14,385 Ninth Year CFAT Rs. 3,28,104 Tenth Year CFAT Rs. 7,55,396
Narain