Corporate Finance

Professor Ashok Thampy

Ungraded Question Week Five

Jay Earth Moving Company Case

You have been asked by the President of Jay Earth Moving Company,
headquartered in Bangalore, to evaluate the proposed acquisition of a new
earthmover.
The earth mover's basic price is Rs. 50 million.
Assume that the depreciation for the mover is 33% of the beginning book value.
The depreciation schedule is given below:
Year 0 1 2 3
Beginning book value 50.00 33.50 22.45
Depreciation 16.50 11.06 7.41
Ending book value 33.50 22.45 15.04

That is, in the first year the depreciation will be 33% of the value of the asset at
the beginning of the period. Since the earth mover is purchased for Rs. 50
million, its beginning book value in year 1 is Rs. 50 million. Depreciation will be
33% of the beginning book value for that year. The ending book value for year 1
is beginning book value minus the depreciation. So ending book value is Rs. 33.5
million in year 1. This becomes the beginning book value in year 2. Depreciation
in year 2 is 33% of beginning book value in year 2.
The mover will be sold after 3 years for Rs. 15.04 million which is equal to the
book value at the end of year 3.
The new earth mover will require an increase in net working capital (spare
parts inventory) of Rs. 4 million, which has to be made in year 0 itself.
Revenue each year from the earthmover will be Rs. 40 million and operating
costs (excluding depreciation) is Rs. 6 million.
JEM's tax rate is 30%.

© All Rights Reserved. This document has been authored by Professor Ashok Thampy and is permitted for use only within the course "Corporate
Finance" delivered in the online course format by IIM Bangalore. No part of this document, including any logo, data, illustrations, pictures, scripts,
may be reproduced, or stored in a retrieval system or transmitted in any firms or by any means – electronic, mechanical, photocopying, recording
or otherwise – without the prior permission of the author.
 Corporate Finance
Professor Ashok Thampy
Ungraded Question Week Five

The table below shows the different components associated with the
calculation of the Free Cash Flow for this company.
JAY EARTH MOVING COMPANY
Year 0 1 2 3
Revenue 40.00 40.00 40.00
Operating costs 6.00 6.00 6.00
Depreciation 16.50 11.06 7.41
PBT 17.50 22.95 26.59
Tax (30%) 5.25 6.88 7.98
PAT 12.25 16.06 18.62
Operating cash flow 28.75 27.12 26.02
Net working capital (NWC) 4.00 4.00 4.00 0.00
Investment in NWC -4.00 0.00 0.00 4.00
Capital expenditure -50.00 15.04
Cash flow -54.00 28.75 27.12 ?

© All Rights Reserved. This document has been authored by Professor Ashok Thampy and is permitted for use only within the course "Corporate
Finance" delivered in the online course format by IIM Bangalore. No part of this document, including any logo, data, illustrations, pictures, scripts,
may be reproduced, or stored in a retrieval system or transmitted in any firms or by any means – electronic, mechanical, photocopying, recording
or otherwise – without the prior permission of the author.