bita Ltd is considering an investment of ₹ 2,80,00,000 (purchase price) in new equipment to replace old equipment with a book value of ₹ 1,20,00,000 and a market value of ₹ 2,00,00,000. If the firm replaces the old equipment with the new equipment, it expects to save ₹ 1,75,00,000 in operating costs the first year. The amount of these savings will grow at a rate of 12 % per year for each of the following three years. The old equipment has a remaining life of four years. It is being depreciated by the straight-line method. 33.3% of the original book value of the new equipment will be depreciated in the first year, 39.9% will be depreciated in the second year, 14.8% will be depreciated in the third year, and 12.0% will be depreciated in the final year. The salvage value of both the old equipment and the new equipment at the end of 4 years is 0. Assume that the purchase and sale of equipment occurs today and all other cash flows occur at the end of their respective years. If the firm’s cost of capital is 14% and is subject to a 40 % tax rate, find: a. the net investment b. the after-tax incremental cash flow at the end of each year c. the internal rate of return on the investment d. the net present value of the investment Should they go ahead with the investment? Explain in your own words the reason for your final conclusion.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Ibita Ltd is considering an investment of ₹ 2,80,00,000 (purchase price) in new equipment to replace old equipment with a book value of ₹ 1,20,00,000 and a market value of ₹ 2,00,00,000. If the firm replaces the old equipment with the new equipment, it expects to save ₹ 1,75,00,000 in operating costs the first year. The amount of these savings will grow at a rate of 12 % per year for each of the following three years.
The old equipment has a remaining life of four years. It is being
Assume that the purchase and sale of equipment occurs today and all other cash flows occur at the end of their respective years. If the firm’s cost of capital is 14% and is subject to a 40 % tax rate, find:
a. the net investment
b. the after-tax incremental cash flow at the end of each year
c. the internal rate of
d. the
Should they go ahead with the investment? Explain in your own words the reason for your final conclusion.
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