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Capital Budgeting

Prof. M S Narasimhan

Exercise

Regal Paints is adding a new unit to produce special grade paints. The new unit requires 2 acres of land and will
be located in the same factory land. The cost of the land related to 2 acres in the books is $ 20000 and the
current market value is $ 80000. The estimated cost of construction of building is $ 160000. Plant and
Equipment and other assets required for the new project is estimated at $ 500000. Factory building will be
depreciated at the rate of 5% per year and other assets are depreciated at the rate of 10% per year. The
company follows straight line method for both accounting and tax purpose. Though the project is expected to
continue for a longer period, the plant and equipment need to be replaced at the end of 10 years. Hence, it was
decided to evaluated the project on the assumption that it will be closed at the end of 10 years. There is no
resale or salvage value of Plant and Equipment. The resale value of the factory building is $ 80000 (i.e. book
value of the factory building). The project requires additional working capital of $ 40000 and the same is released
at the end of 10 years. Regal Paints required rate of return is 15%. The project is expected to generate a net
income of $ 140000 per year for the next 10 years as detailed below:

Revenue 700000

Less: Material Cost 280000

Labour Cost 125000

Depreciation 33000

Other Expenses 62000 500000

Profit before Taxes 200000

Less: Tax @ 30% 60000

Net Income 140000

Required:

(a) Find the Net Present Value of the project.

(b) Find IRR of the project

(c) Find Payback period and Discounted Payback period.

(d) Find the Profitability Index

(e) Do you recommend the project to Regal Paints?

© All Rights Reserved. This document has been authored by Prof. M S Narasimhan and is permitted for use only within the course
Accounting and Finance delivered in the online course format by IIM Bangalore. No part of this document, including any logo, data,
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