IAI nov 2008

You are examining the viability of a capital investment that your firm is interested in.
The project will require an initial investment of Rs.500,000 and the projected revenues are
Rs.400,000 a year for 5 years. The projected cost-of-goods-sold is 40% of revenues and the tax
rate is 40%. The initial investment is primarily in plant and equipment and can be depreciated
straight-line over 5 years (the salvage value is zero). The project makes use of other resources
that your firm already owns:
Two employees of the firm, each with a salary of Rs.40,000 a year, who are currently employed
by another division will be transferred to this project. The other division has no alternative use
for them, but they are covered by a union contract which will prevent them from being fired for
3 years (during which they would be paid their current salary).
The project will use excess capacity in the current packaging plant. While this excess capacity
has no alternative use now, it is estimated that the firm will have to invest Rs. 250,000 in a new
packaging plant in year 4 as a consequence of this project using up excess capacity (instead of
year 8 as originally planned).
The project will use a van currently owned by the firm. While the van is not currently being
used, it can be rented out for Rs. 3000 a year for 5 years. The book value of the van is Rs.10,000
and it is being depreciated straight line (with 5 years remaining for depreciation).
The discount rate to be used for this project is 10%.
Should you go in for this capital investment?




plz provide an easy way of solving this....

 

Have you looked at the solution? Is there any part which is not clear to you?

 

Looks to me like you need to map out the cashflows over time and discount them at 10%. An NPV>0 suggests the project should go ahead (bearing in mind other considerations, such as availability of alternative more prfitable projects)

 

c the solution has used the opportunity cost method...n is simply un-understandable.....there may be some easy way out.....

 

and i tried the discounting method...but cas outflows occur at different time period...n ended up confusing my self...

 

I tried solving it using table NPV method. Does not work. It is difficult to incorporate the opportunity costs in the table.

The solution given by them is the easiest method. Just have to take each situation separately and calculate the opportunity cost for each of them