Question

Sheer ICT Ltd is considering an investment of Kes 1,000,000.00 in new technology. The new equipment would have a useful life of 4 years with a scrap value of Kes 100,000.00. The company can claim capital allowances at 25% on reducing balance method. The company pays tax one year in arrears. The tax rate is 30%. The company uses a discount rate of 13% for such projects.
Additional information
1. A license fee of Kes 104,000.00 is payable at the end of year l and will increase at 3% per year in each subsequent year.
2. The new technology will reduce operating costs by Kes 6.00 per unit in current price term before taking account of inflation at 4% per year.
3. Sheer will finance the purchase of new equipment with a four (4) year loan paying
interest at 10% before tax per year.
4. Forecast production over the life of the equipment;
Year2011201220132014
Production (units per year)60,00075,00095,00080,000
Required
(i) Evaluate the above project in nominal terms
(ii)Graphically, what is the Net Present Value of the Project?
(ii) Using scenario manager find the net present value at the following cost of equipment, Kes 500,000. Kes 700,000. Kes 900,000. Kes 1,200,000, What assumption did you make

 

 

Answer 1

Information is given in Question	Figure in KES
Investment	1000000
Useful Life 4 years
Scrap Value	100000
Depreciation Rate Reducing method	0
Tax Rate one year arrear	0
Kes	0
License fee and increase 3%	104000
Reduce operating cost by 3% per year
Loan rate 10 % before tax

 

i)

Particulars	2011	2012	2013	2014
Production unit	60000	75000	95000	80000
Saving in Operating costs by 6	-360000	-450000	-570000	-480000
License fee with increase 3%	107120	110334	113644	117053
Tax Saving on Capital allowance @30 %	-75000	-56250	-42188	-31641
Loan Intrest rate after tax 7%	754523	491862	210815	89905
Total Cost nominal Cost	426643	95946	-287729	-304683

 

Working Note
Calculation of Depreciation
Op Balanace	1000000	750000	562500	421875
(-) Scrap Vale	0
	1000000	750000	562500	421875
Capital allowance @25%	-250000	-187500	-140625	-105469
	750000	562500	421875	316406
Tax Saving on Capital allowance @30 %	-75000	-56250	-42188	-31641

 

Calculation of Loan interest
total Pv factor @10 % for years	3	Used here Discount factor table
Equal EMI	1000000	315477
	3
Op Balance	1000000	754523	491862	210815
Interest@7%	70000	52817	34430	14757
Total	1070000	807339	526292	225572
(-) Instalment	315477	315477	315477	315477
	754523	491862	210815	-89905

 

ii)

 

iii)

Inflow	500000	700000	900000	1200000
Total Nominal Cost	426643	95946	-287729	-304683
NPV	73357	604054	1187729	1504683

 

Assumption:

It is better to accept 1200000 because NPV more positive in the given option.