# Business Finance Assignment No. 2 Solution and Discussion Spring 2014 of Virtual University (VU)

• Calculate net cash flows by incorporating the effects of tax and depreciation.

• Evaluate any proposed project by using different capital budgeting techniques.

• Derive inferences regarding the acceptance/rejections of the project.

The Case:

Mr. Waseem wants to start “Printing on Packages” business. He wants to start this business with

4 printing machines. He estimates that the required investment for the business is Rs. 40 Million.

He projects that revenue (before tax and depreciation) from the business will be Rs.8 Million for

the first year and it will keep on growing at a rate of 5.5% annually till the 10th year.

Some other information regarding the project is as follows:

• Annual depreciation will be Rs. 4 Million under the straight line method.

• Cost of capital is 10% while the rate of tax is 33%.

Suppose you are running a financial consultancy firm, Mr. Waseem wants to get his project

evaluated by your firm. You have to suggest Mr. Waseem about the feasibility of the project after

performing different techniques of financial analysis to start a new project.

Requirement:

1. Calculate net cash flows for 10 years. (10 Marks)

2. Evaluate the project by using the following capital budgeting techniques:

a. Payback Period (The desired payback period is 4.5 years) (04 Marks)

b. Net Present Value (10 Marks)

c. Profitability Index (03 Marks)3. Is there any contradiction among the results of above used techniques? What would be

your final recommendation regarding the acceptance/rejection of the project? Support

your recommendation with financial rationale. (03 Marks)

Special Note: Complete calculations are required for Part (1) and Part (2). Incomplete

calculations will result in loss of marks.

SOLUTION GUIDELINES:

• Do prepare the solution after completely reading and understanding the questions.

• Put your genuine efforts in order to understand the concepts thoroughly.

• Provide complete calculations first two parts of the question.

Solution:

year
1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th
Revenue
8,000,000
8,440,000
8,904,200
9,393,931
9,910,597
10,455,68
11,030,742
11,637,433
12,277,492
12,952,754
Less Deprecation
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
EBIT
4,000,000
4,440,000
4,904,200
5,393,931
5,910,597
6,455,68
7,030,742
7,637,43
8,277,492
8,952,754
Taxes @ 33%
1,320,000
1,465,200
1,618,386
1,779,997
1,950,497
2,130,374
2,320,145
2,520,353
2,731,572
2,954,409
Earnings after Taxes
2,680,000
2,974,800
3,285,814
3,613,934
3,960,100
4,325,306
4,710,597
5,117,080
5,545,920
5,998,345
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
Net Cash flow
6,680,000
6,974,800
7,285,814
7,613,934
7,960,100
8,325,306
8,710,597
9,117,080
9,545,920
9,998,345

2. Evaluate the project by using the following capital budgeting techniques:

a. Payback Period (The desired payback period is 4.5 years) (04 Marks)

Solution:

Payback Period

1st year
2nd year
3rd year
4th year
5th year
6th year

Initial investment
40,000,000

Cash flows
(40,000,000)
6,680,000
6,974,800
7,285,814
7,613,934
7,960,100
8,325,306
Cumulative cash

flows

(33,320,000)
(26,345,200)
(19,059,386)
(11,445,452
(3,485,352)
4,839,954

Calculation:

Investment return in 5.42 Years 5.42 Years

Days 153 5 Months

b. Net Present Value (10 Marks)

Solution:

Year 1
1/(1+0.1)^1
0.9091
6680000
6072727
Year 2
1/(1+0.1)^2
0.8264
6974800
5764298
Year 3
1/(1+0.1)^3
0.7513
7285814
5473940
Year 4
1/(1+0.1)^4
0.6830
7613934
5200419
Year 5
1/(1+0.1)^5
0.6290
7960100
4942596
Year 6
1/(1+0.1)^6
0.5645
8325306
4699418
Year 7
1/(1+0.1)^7
0.5132
8710597
4469914
Year 8
1/(1+0.1)^8
0.4665
9117080
4253185
Year 9
1/(1+0.1)^9
0.4241
9545920
4048402
Year 10
1/(1+0.1)^10
0.3855
9998345
3854795

Calculation:

6072727+5764298+5473940+5200419+4942596+4699418+4469914+4253185+4048402+3854795 = 48779694

Investment value = 40,000,000

NPV = 48779694 – 40,000,000 = 8779694 = 8.78million