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Question 3 (a) SRT Limited manufactures steel rods and is now considering to purchase a new aluminium smelting and moulding plant. This plant will have the cost of ` 20,00,000 to purchase and install the plant. It has a useful life of 5 years with a residual value of ` 1,00,000. Production and sales from the new plant are expected to be 1,00,000 units per year. Other estimates are as follows: Selling Price `150 per unit Direct Cost `100 per unit Fixed cost (including depreciation) is ` 8,00,000 per annum. Marketing and promotion cost not included in the above will be ` 1,00,000 and ` 1,60,000 for years 1 and 2, respectively. Additionally, investment in debtors and stocks will increase in year 1 by ` 1,50,000 and ` 2,00,000, respectively. Creditors will also increase by ` 1,00,000 in year 1. Thus, debtors, stocks, and creditors will be recouped at the end of the fifth year. The cost of capital is 18%. Corporate tax is 30% and is paid in the year in which profits are made. Depreciation is tax deductible. The company follows straight line method of depreciation. Required: (i) Calculate the Net Present Value and Profitability Index of the project. (ii) Advise SRT Limited whether the plant should be purchased. The PV factors at 18% are: Year 1 2 3 4 5 PV factor 0.847 0.718 0.609 0.516 0437 (5 + 1 = 6 Marks) FINANCIAL MANAGEMENT AND STRATEGIC MANAGEMENT (b) The equity share capital of Sky Pack Ltd. as on 31st March, 2024 was ` 2,00,000. The relevant ratios of the company are as follows: Current debt to Total debt 0.35 Total debt to Owner's equity 0.65 Fixed assets to Owner's equity 0.55 Total assets turnover 2.5 times Inventory turnover 10 times You are required to prepare the Balance Sheet of Sky Pack Ltd. as on 31stMarch, 2024. (4 Marks)

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Detailed Solution & Explanation

### Solution to Question 3 #### (a) Financial Feasibility Analysis of SRT Limited's Plant **Working Notes:** 1. **Calculation of Annual Depreciation:** * Cost of Plant = Rs. 20,00,000\displaystyle \text{Rs. } 20,00,000 * Useful Life = 5 years\displaystyle 5 \text{ years} * Residual Value = Rs. 1,00,000\displaystyle \text{Rs. } 1,00,000 * Depreciation (Straight-Line Method) = Cost−Residual ValueLife=20,00,000−1,00,0005=Rs. 3,80,000 per annum\displaystyle \frac{\text{Cost} - \text{Residual Value}}{\text{Life}} = \frac{20,00,000 - 1,00,000}{5} = \text{Rs. } 3,80,000 \text{ per annum}. 2. **Calculation of Annual Operating Fixed Costs (excluding depreciation):** * Total Fixed Cost (including depreciation) = Rs. 8,00,000 per annum\displaystyle \text{Rs. } 8,00,000 \text{ per annum}. * Fixed Cost (excluding depreciation) = 8,00,000−3,80,000=Rs. 4,20,000 per annum\displaystyle 8,00,000 - 3,80,000 = \text{Rs. } 4,20,000 \text{ per annum}. 3. **Working Capital Cash Flow Details:** * Debtors increase in Year 1 = Rs. 1,50,000\displaystyle \text{Rs. } 1,50,000 * Stocks increase in Year 1 = Rs. 2,00,000\displaystyle \text{Rs. } 2,00,000 * Creditors increase in Year 1 = Rs. 1,00,000\displaystyle \text{Rs. } 1,00,000 * Net Working Capital required in Year 1 = 1,50,000+2,00,000−1,00,000=Rs. 2,50,000\displaystyle 1,50,000 + 2,00,000 - 1,00,000 = \text{Rs. } 2,50,000. * Since this is recouped at the end of the 5th year, we add a cash inflow of Rs. 2,50,000\displaystyle \text{Rs. } 2,50,000 in Year 5.
**Table: Calculation of Annual Cash Flows (Rs.)** | Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | | :--- | :---: | :---: | :---: | :---: | :---: | | Production & Sales (units) | 1,00,000 | 1,00,000 | 1,00,000 | 1,00,000 | 1,00,000 | | **Sales Revenue** (@ Rs. 150/unit) | 1,50,00,000 | 1,50,00,000 | 1,50,00,000 | 1,50,00,000 | 1,50,00,000 | | **Less: Operating Costs:** | | | | | | | Direct Costs (@ Rs. 100/unit) | 1,00,00,000 | 1,00,00,000 | 1,00,00,000 | 1,00,00,000 | 1,00,00,000 | | Marketing & Promotion Cost | 1,00,000 | 1,60,000 | — | — | — | | Fixed Costs (excl. depreciation) | 4,20,000 | 4,20,000 | 4,20,000 | 4,20,000 | 4,20,000 | | Depreciation | 3,80,000 | 3,80,000 | 3,80,000 | 3,80,000 | 3,80,000 | | **Total Costs** | **1,09,00,000** | **1,09,60,000** | **1,08,00,000** | **1,08,00,000** | **1,08,00,000** | | **Profit Before Tax (PBT)** | **41,00,000** | **40,40,000** | **42,00,000** | **42,00,000** | **42,00,000** | | Less: Tax @ 30% | 12,30,000 | 12,12,000 | 12,60,000 | 12,60,000 | 12,60,000 | | **Profit After Tax (PAT)** | **28,70,000** | **28,28,000** | **29,40,000** | **29,40,000** | **29,40,000** | | Add: Depreciation (Non-Cash) | 3,80,000 | 3,80,000 | 3,80,000 | 3,80,000 | 3,80,000 | | **Cash Inflow After Tax** | **32,50,000** | **32,08,000** | **33,20,000** | **33,20,000** | **33,20,000** | | Add: Recoupment of Working Capital | — | — | — | — | 2,50,000 | | Add: Salvage Value of Plant | — | — | — | — | 1,00,000 | | **Net Cash Inflow** | **32,50,000** | **32,08,000** | **33,20,000** | **33,20,000** | **36,70,000** |
**Table: Net Present Value (NPV) Calculation (Rs.)** | Year | Net Cash Inflow (Rs.) | PV Factor @ 18% | Present Value (Rs.) | | :--- | :---: | :---: | :---: | | 1 | 32,50,000 | 0.847 | 27,52,750 | | 2 | 32,08,000 | 0.718 | 23,03,344 | | 3 | 33,20,000 | 0.609 | 20,21,880 | | 4 | 33,20,000 | 0.516 | 17,13,120 | | 5 | 36,70,000 | 0.437 | 16,03,790 | | **Total PV of Inflows** | | | **1,03,94,884** |
**Evaluation Alternatives (Based on timing of Working Capital Investment):** * **Alternative 1: Working Capital is invested at the beginning of the project (Year 0):** * Total Initial Outlay = Cost of Plant+Working Capital=20,00,000+2,50,000=Rs. 22,50,000\displaystyle \text{Cost of Plant} + \text{Working Capital} = 20,00,000 + 2,50,000 = \text{Rs. } 22,50,000. * **Net Present Value (NPV):** NPV=PV of Cash Inflows−Initial Outlay=1,03,94,884−22,50,000=Rs. 81,44,884\text{NPV} = \text{PV of Cash Inflows} - \text{Initial Outlay} = 1,03,94,884 - 22,50,000 = \text{Rs. } 81,44,884 * **Profitability Index (PI):** PI=PV of Cash InflowsInitial Outlay=1,03,94,88422,50,000≈4.62\text{PI} = \frac{\text{PV of Cash Inflows}}{\text{Initial Outlay}} = \frac{1,03,94,884}{22,50,000} \approx 4.62 * **Alternative 2: Working Capital is invested at the end of Year 1:** * Total PV of cash outflows = Cost of Plant+(Working Capital×PV factor for Year 1)=20,00,000+(2,50,000×0.847)=Rs. 22,11,750\displaystyle \text{Cost of Plant} + (\text{Working Capital} \times \text{PV factor for Year 1}) = 20,00,000 + (2,50,000 \times 0.847) = \text{Rs. } 22,11,750. * **Net Present Value (NPV):** NPV=1,03,94,884−22,11,750=Rs. 81,83,134\text{NPV} = 1,03,94,884 - 22,11,750 = \text{Rs. } 81,83,134 * **Profitability Index (PI):** PI=1,03,94,88422,11,750≈4.70\text{PI} = \frac{1,03,94,884}{22,11,750} \approx 4.70 **Advice to SRT Limited:** Since the project has a positive Net Present Value (NPV>0\displaystyle NPV > 0) and a Profitability Index greater than 1 (PI>1\displaystyle PI > 1), SRT Limited should purchase and install the new aluminum smelting and moulding plant. --- #### (b) Balance Sheet of Sky Pack Ltd. as on 31st March, 2024 **Working Notes:** 1. **Total Debt:** Total Debt to Owner’s Equity=0.65\text{Total Debt to Owner's Equity} = 0.65 Owner’s Equity=Equity Share Capital=Rs. 2,00,000\text{Owner's Equity} = \text{Equity Share Capital} = \text{Rs. } 2,00,000 Total Debt=0.65×2,00,000=Rs. 1,30,000\text{Total Debt} = 0.65 \times 2,00,000 = \text{Rs. } 1,30,000 2. **Current Debt & Long-Term Debt:** Current Debt to Total Debt=0.35\text{Current Debt to Total Debt} = 0.35 Current Debt=0.35×Total Debt=0.35×1,30,000=Rs. 45,500\text{Current Debt} = 0.35 \times \text{Total Debt} = 0.35 \times 1,30,000 = \text{Rs. } 45,500 Long-Term Debt=Total Debt−Current Debt=1,30,000−45,500=Rs. 84,500\text{Long-Term Debt} = \text{Total Debt} - \text{Current Debt} = 1,30,000 - 45,500 = \text{Rs. } 84,500 3. **Fixed Assets:** Fixed Assets to Owner’s Equity=0.55\text{Fixed Assets to Owner's Equity} = 0.55 Fixed Assets=0.55×2,00,000=Rs. 1,10,000\text{Fixed Assets} = 0.55 \times 2,00,000 = \text{Rs. } 1,10,000 4. **Total Equity and Liabilities (and Total Assets):** \text{Total Equity & Liabilities} = \text{Owner's Equity} + \text{Total Debt} \text{Total Equity & Liabilities} = 2,00,000 + 1,30,000 = \text{Rs. } 3,30,000 *Therefore, Total Assets = Rs. 3,30,000.* 5. **Inventory:** * Total Assets Turnover = 2.5 times * Inventory Turnover = 10 times * Ratio of Inventory to Total Assets: InventoryTotal Assets=Sales/Inventory TurnoverSales/Total Assets Turnover=Total Assets TurnoverInventory Turnover=2.510=0.25\frac{\text{Inventory}}{\text{Total Assets}} = \frac{\text{Sales} / \text{Inventory Turnover}}{\text{Sales} / \text{Total Assets Turnover}} = \frac{\text{Total Assets Turnover}}{\text{Inventory Turnover}} = \frac{2.5}{10} = 0.25 * Inventory = 0.25×Total Assets=0.25×3,30,000=Rs. 82,500\displaystyle 0.25 \times \text{Total Assets} = 0.25 \times 3,30,000 = \text{Rs. } 82,500. *(Alternatively: Sales = Total Assets ×\displaystyle \times 2.5 = 3,30,000 ×\displaystyle \times 2.5 = Rs. 8,25,000. Inventory = Sales / Inventory Turnover = 8,25,000 / 10 = Rs. 82,500).* 6. **Cash (Balancing Figure on Asset side):** Cash=Total Assets−Fixed Assets−Inventory\text{Cash} = \text{Total Assets} - \text{Fixed Assets} - \text{Inventory} Cash=3,30,000−1,10,000−82,500=Rs. 1,37,500\text{Cash} = 3,30,000 - 1,10,000 - 82,500 = \text{Rs. } 1,37,500
**Balance Sheet of Sky Pack Ltd. as on 31st March, 2024** | Liabilities | Amount (Rs.) | Assets | Amount (Rs.) | | :--- | :---: | :--- | :---: | | Equity Share Capital | 2,00,000 | Fixed Assets | 1,10,000 | | Long-Term Debt | 84,500 | Inventory | 82,500 | | Current Debt | 45,500 | Cash (balancing figure) | 1,37,500 | | **Total** | **3,30,000** | **Total** | **3,30,000** |

Key Concepts to Understand

Depreciation

Allocation of the cost of a tangible fixed asset over its useful life due to wear and tear, efflux of time, or obsolescence.

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