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Sample of Finance homework Illustrations and Solutions:

Illustration: 1. ABC Ltd. Is evaluating a capital proposal for which relevant figures are as follows:

Cost of the plant $. 11, 00,000

Installation cost $. 3,400

Economic life 7 years

Scrap value $ 30,000

Profit before depreciation and tax $ 2,00,000

Tax rate 50%

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Solution:

Annual depreciation charge

($. 11, 03,400 – $. 30,000) /7 1,53,343

Profit before depreciation, and taxes 2,00,000

-Depreciation 1,53,343

Profit before Tax 46,657

-Tax @ 50% 23,329

Profit after Tax 23,328

+ Depreciation (added back) 1,53,343

Cash inflow (Yearly) 1,76,671

The plant has an initial cash outflow of $. 11,03,400 ($. 11,00,000 + $. 3,400), and its annual cash

inflows for 7 year/will be $. 1,76,671 p.a. However, in the 7th year, there will be an additional cash

inflow of $. 30,000 i.e., the scrap value. Therefore, in the 7th year, the total cash inflow will be $.

2,06,671.

It may be noted that the Examples 3.1 and 3.2 make an assumption that all the sales and expenses

have been affected in cash. However, in practice there is a time gap between the occurrence of sales

and expenses and their incidence on cash flow. Thus, each transaction of sales and expenses need to

be analyzed to find out the cash flow associated with it. Similarly, pattern of receipts from

receivables (debtors and bill) and the pattern of payments to payable (creditors and bills) should also

be analyzed to assess the effect on cash flow. But this is too difficult and rather impossible to apply.

Moreover, in capital budgeting, the emphasis is on yearly basis cash flows rather than intra-year

cash flows. Therefore, in capital budgeting, only the total cash flows are relevant and so, the profit

figure is adjusted only for non-cash items.

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Illustration: 2 A firm buys and asset costing $. 1,00,000 and expects operating profits (before

depreciation @ 20% WDV and tax @ 30%) of $. 30,000 p.a. for the next four years after which the

asset would be disposed off for $. 45,000. Find out the cash flows for different years.

Solution :

Initial Outflow:

Cost of the Asset $. 1,00,000

Subsequent Annual Inflows: The subsequent cash inflows from the asset may be found as under:

Year WDV Dep. PBD PBT Tax PAT CF

(2) (3) (4 = 3-2) @30% (5) (5 + 2)

1. $. 1,00,000 $.20,000 $.30,000 $.10,000 $.3,000 $.7,000 $27,000

2. 80,000 16,000 30,000 14,000 4,200 9,800 25,800

3. 64,000 12,800 30,000 17,200 5,160 12,040 24,840

4. 51,200 10,240 30,000 19,760 5,928 13,832 24,072

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Terminal Cash Inflow :

Scrap Value of the Asset $ 45,000

Profit on sale: 45,000

Sale Value 40,960

WDV (51,200 – 10,240) 4,040

Profit $ 1,212

Tax @ 30% on $. 4,040 $ 43,788

Net Cash Inflow (45,000 – 1,212) $ 43,788

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Illustration: 3 following is the income statement of a project, on the basis of which calculate the

annual cash inflows.

Income Statement of the Project

$. 4, 75,000

Net Sales revenue $. 2,00,000

-Cost of goods sold 1,00,000

- General Expenses 50,000 3,50,000

-Depreciation 1,25,000

Profit before interest and taxes 25,000

-Interest

Profit before tax 1,00,000

-Tax @ 40% 40,000

Profit after tax 60,000

Solution:

The income statement of the project shows that an interest charge of $. 25,000 is payable on the

funds raised for financing the project. This interest payment is a charge for ascertaining the

accounting profit, but is irrelevant for ascertaining the cash flows. Therefore, the annual cash flow

from the project can be calculated as follows:

Calculation of Annual Cash Inflows

Net Sales revenue $. 4,75,000

-cost of goods sold $ 2,00,000

-General Expenses 1,00,000

-Depreciation 50,000 3,50,000

Profit before and taxes 1,25,000

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-Tax @ 40% 50,000

+ Depreciation (added back) 75,000

50,000

Net cash inflow 1,25,000

The cash inflow can also be ascertained as follows :

Net profit (as shown in Income Statement) 60,000

+ Depreciation 50,000

+ Interest 25,000

1,35,000

-Tax-effect of interest ($. 25,000 × 40%) 10,000

Annual cash inflow 1,25,000