Question
Akhil is all set to take over the management of the two year old pharma division of their family firm HPL, from Rakesh. Currently, the
Akhil is all set to take over the management of the two year old pharma division of their family firm HPL, from Rakesh. Currently, the pharma division has only one machinery which has a remaining economic life of five years after which it would be withdrawn. Immediately on taking over, Akhil plans to sell the existing mail machinery, originally bought at Rs. 40 Lakhs and install a new one costing Rs. 80 Lakhs. whose better effeciency would ensure a 5% increase in the annual sales over the present projections. While the total annual manufacturing costs (other than depreciation) would remain unchanged throughout because of cost effeciencies, it would be necessary to make a fresh working capital investment of Rs. 8 lacs. To ensure safety of the costly raw material, he plans to utilize free of cost, a solid room in the backyard of the factory, which is about to be leased out by another division to a neighboring unit at a rental of Rs. 1 lakh per annum.
The current annual sales is at Rs. 400 Lakh and as per the present projections the annual sales would increase by 20% in the next two years and decline by 10% thereafter. While Rakesh's current remuneration is Rs. 5 Lacs. Akhil's would be Rs. 4 Lacs and his annual increment 25 % against the 5 % of Rakesh.
To Ensure that the changes to be affected by him are worthwhile. Akhil seeks your help in calculating the NPV and IRR.
Additional Information:
1. At the end of any year the net salvage values of both existing and new machinery would be equal to thei respective book values at that time and the working capital could be recovered at par.
2. Depreciation is calculated under Written down value (WDV) method on both the existing and proposed new machinery at 25%
3. Income tax for the firm is 30%
4. Cost of Capital is 12%
Please share your detailed calculations.
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