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Pak Arab Fertilizer Limited company is considering acquisition of a new plant that costs Rs 20,000,000. The plant has useful life of five (5) years. It has a salvage value of Rs. 5,000,000 and it will

Pak Arab Fertilizer Limited company is considering acquisition of a new plant that costs Rs 20,000,000. The plant has useful life of five (5) years. It has a salvage value of Rs. 5,000,000 and it will increase the production by 20,000 units. The finished product of the company sells for Rs.400 per unit. The production & operating costs excluding depreciation are Rs.100 per unit. The plant will be depreciated using straight line balance method. The incremental tax rate of the company is 30%. The plant will be financed as under:
 
Sources of Financing (Amount)
Ordinary Shares Rs. 8,000,000
Preference Shares Rs. 6,000,000
15% Term Loan Rs. 6,000,000
Total Finance Rs. 20,000,000
 
An average market rate of return on equity is 14%, while preference shares yield is16%.
 
Required:
a. On the basis of available information, analyze if the company should invest in the plant. You may use present value approach in taking your decision. (Marks 10)
Part B
Crescent Textile Mills Limited is considering the replacement of an existing machine. The new machine costs Rs. 1.2 million and requires installation costs of Rs.150,000. The existing machine can be sold currently for Rs.185,000 before taxes. It is 3 years old, cost Rs.800,000 new, and has a Rs.500,000 book value and a remaining useful life of 5 years. It was being depreciated under straight line method. If it is held for 5 more years, the machine’s market value at the end of year 5 will be 0. Over its 5-year life, the new machine should reduce operating costs by Rs.350,000 per year. The new machine will be depreciated under straight line method. The new machine can be sold for Rs.200,000 net of removal and cleanup costs at the end of 5 years. An increased investment in net working capital of Rs.25,000 will be needed to support operations if the new machine is acquired. Assume that the firm has adequate operating income against which to deduct any loss experienced on the sale of the existing machine. The firm has a 9% cost of capital and is subject to a 40% tax rate.
 
Required:
a. Develop the relevant cash flows needed to analyze the proposed replacement. (Marks 3)
b. Determine net present value (NPV) of the proposal. (Marks 3)
c. Make a recommendation to accept or reject the replacement proposal and justify your answer.
(Marks 3) (Total Marks 10)
Part C
World Call Communications is trying to estimate the first-year net cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:
Sales revenues Rs.10 million
Operating costs (excluding depreciation) 7 million
Depreciation 2 million
Interest expense 2 million
 
The company has a 40% tax rate, and its WACC is 10%.
Required
a. What is the project’s net cash flow for the first year? (Marks 5)
b. If the tax rate dropped to 30%, how would that change your answer to Part a? (Marks 5)

Apr 12 2021 View more View Less

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