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Loyal Textile Ltd is considering the replacement of one of its old textile machines. The existing machine is 5 years old, has a current market value of Rs.30, 000 and a remaining depreciable life of 10 years.The machine was originally purchased for Rs .75, 000 and is being depreciated at Rs.5, 000 per annum for tax purposes.
The new machine will cost Rs.1, 50,000 and will be depreciated on a straight line basis over 10 years
with no salvage value. The management estimates that with expanded operations, there will be a need of
additional working capital of Rs.30, 000. The new machine will increase the revenue of the firm to
Rs.40, 000. The variable cost will go up from Rs.2, 00,000 to Rs.2, 10,000. The company’s tax rate is
35% and the cost of capital is 10%.
Should the company replace its existing machine? The working capital will be fully recovered at the
end of the 10th year.
Note: (a) P.V.Annuity Re.1 at 10% for 10 years is 6.145.
(b) P.V.of Re.1 at 10% for 10 years is 0.386. (5 Marks)
2. Asian Motors Ltd needs Rs.12 lakhs for establishment of a new factory which would yield an annual EBIT of Rs. 2 lakhs. The company has the objective of maximizing the earnings per share. It is considering the possibility of using equity shares plus raising a debt of Rs.2 lakhs, 6 lakhs or 10 lakhs.
The current market price per share is Rs.40.It is expected to drop to Rs.25 if the market borrowings exceed Rs.7, 50,000.
Cost of borrowing will be as follows:
Up to Rs.2, 50,000 – 10% p.a
Between 2, 50,001 and Rs.6, 25,000 – 14% p.a
Between 6, 25,001 and Rs.10, 00,000 – 16% p.a (5…
Loyal Textile Ltd is considering the replacement of one of its old textile machines. The existing machine is 5 years old, has a current market value of Rs.30, 000 and a remaining depreciable life of 10 years.The machine was originally purchased for Rs .75, 000 and is being depreciated at Rs.5, 000 per annum for tax purposes.
The new machine will cost Rs.1, 50,000 and will be depreciated on a straight line basis over 10 years
with no salvage value. The management estimates that with expanded operations, there will be a need of
additional working capital of Rs.30, 000. The new machine will increase the revenue of the firm to
Rs.40, 000. The variable cost will go up from Rs.2, 00,000 to Rs.2, 10,000. The company’s tax rate is
35% and the cost of capital is 10%.
Should the company replace its existing machine? The working capital will be fully recovered at the
end of the 10th year.
Note: (a) P.V.Annuity Re.1 at 10% for 10 years is 6.145.
(b) P.V.of Re.1 at 10% for 10 years is 0.386. (5 Marks)
2. Asian Motors Ltd needs Rs.12 lakhs for establishment of a new factory which would yield an annual EBIT of Rs. 2 lakhs. The company has the objective of maximizing the earnings per share. It is considering the possibility of using equity shares plus raising a debt of Rs.2 lakhs, 6 lakhs or 10 lakhs.
The current market price per share is Rs.40.It is expected to drop to Rs.25 if the market borrowings exceed Rs.7, 50,000.
Cost of borrowing will be as follows:
Up to Rs.2, 50,000 – 10% p.a
Between 2, 50,001 and Rs.6, 25,000 – 14% p.a
Between 6, 25,001 and Rs.10, 00,000 – 16% p.a (5…
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