Beta Auto Ltd is considering the manufacture of a new bike, Pale, for which the following information has been gathered. Pale is expected to have a product life cycle of five years after which it will be withdrawn from the market. The sales from this product is expected to be as follows:
Year 1 2 3 4 5
Sales (Rs. in million) 700 850 1100 1000 800 •
The capital equipment required for manufacturing Pale costs Rs.600 million and it will be depreciated at the rate of 25 percent per year as per the WDV method for tax purposes. The expected net salvage value after 5 years is Rs.100 million.
• The working capital requirement for the project is expected to be 10% of sales. Working capital level will be adjusted at the beginning of the year in relation to the sales for the year. At the end of five years, working capital is expected to be liquidated at par, barring an estimated loss of Rs.5 million on account of bad debt, which of course, will be tax-deductible expense.
• The accountant of the firm has provided the following estimates for the cost of Pale.
Raw material cost :40 percent of sales
Variable manufacturing cost : 20 percent of sales
Fixed annual operating and maintenance costs : Rs.2.5 million
Variable selling expenses : 15 percent of sales
The tax rate for the firm is 30 percent.
Required:
(a) Estimate the post-tax incremental cash flows for the project to manufacture Pale.
(b) What is the NPV of the project if the cost of capital is 18 percent?