Question 1: Company A is considering a project that requires initial investment of Rs. 2 million. The finance manager believes that the project will generate future cash inflows of Rupees 30,000, 38,000, 25,000, 22,000, 36,000, 40,000, 40,000, 28,000, 24,000 and 24,000 from year 1 to year 10. You are required to calculate Payback Period.
Solution
| Years | Cash inflows | Cumulative | |
| 1 | 30,000 | cash inflows | |
| 2 | 38,000 | 30,000 | |
| 3 | 25,000 | 68,000 | |
| 4 | 22,000 | 93.000 | |
| 5 | 36,000 | 1,15,000 | |
| 6 | 40,000 | 1,51,000 | |
| 7 | 40,000 | 1,91,000 | |
| 8 | 28,000 | 2,31,000 | |
| 9 | 24,000 | 2,59,000 | |
| 10 | 24,000 | 2,83,000 | |
| 3,07,000 |
TCCL is a cement manufacturing company. In order to meet the increased demand of its products, it has decided to upgrade the plant capacity. There are three plant variants are available which the management is considering to choose. Following details are available with sales figure based on cash basis. Interest on capital is 10% while applicable tax rate on company is 40%. You are required to analyse the three options using Payback Period.
| Particulars | Plant 1 | Plant 2 | Plant 3 |
| Initial investment required | 3,00,000 | 3,00,000 | 3,00,000 |
| Estimated annual turnover/ sales | 5,00,000 | 4,00,000 | 4,50,000 |
| Production cost (estimated) : | |||
| Direct materials | 40,000 | 50,000 | 48,000 |
| puriculars | Machine 1 | Machine 2 | Machine 3 |
| Direct labour | 50,000 | 30,000 | 36,000 |
| Factory overheads | 60,000 | 50,000 | 58,000 |
| Administration costs | 20,000 | 10,000 | 15,000 |
| Selling and distribution costs | 10,000 | 10,000 | 10,000 |
The useful life of plant 1 is 2 years, while for other plants it is 3 years. The scrap values of the plants are 40,000, 25,000 and 30,000 respectively.
Required:
Analyse the three expansion options using Pay Back Period.
Solution
| Plant 1 | Plant 2 | Plant 3 | ||
| Initial investment | (i) | 3,00,000 | 3,00,000 | 3,00,000 |
| Sales | (a) | 5,00,000 | 4,00,000 | 4,50,000 |
| Costs : | ||||
| Direct material | 40,000 | 50,000 | 48,000 | |
| Direct labour | 50,000 | 30,000 | 36,000 | |
| Factory overhead | 60,000 | 50,000 | 58,000 | |
| Depreciation | 1,30,000 | 91,667 | 90,000 | |
| Administration cost | 20,000 | 10,000 | 15,000 | |
| Selling and distribution | 10,000 | 10,000 | 10,000 | |
| Interest on capital | 30,000 | 30,000 | 30,000 | |
| Total cost | (b) | 3,40,000 | 2,71,667 | 2,87,000 |
| Profit before tax | (a) (b) | 1,60,000 | 1,28,333 | 1,63,000 |
| Less: Tax @ 40% | 64,000 | 51,333 | 65,200 | |
| 96,000 | 77,000 | 97,800 | ||
| Profit after tax | 1,30,000 | 91,667 | 90,000 | |
| Add : Depreciation | ||||
| Net cash flow | (ii) | 2,26,000 | 1,68,667 | 1,87,800 |
| Pay back period (years) | (i)/(ii) | 1.33 | 1.78 | 1.60 |
As plant 1 has low pay back period, it is the preferred option.