A private energy trading company is considering the acquisition of a heavy crude container. This is to handle a variety of stocks that are expected to last for the next 5 years. The cost of the project is estimated to be 35 crores with an estimated life of 5 years. The machine is eligible for depreciation at the rate of 20% per annum on straight line basis with a scrap value of 5 crores. The benefits from the investment (Profit after Depreciation but before Tax) during its life of 5 years are estimated to be as follows:
|
1
|
2
|
3
|
4
|
5
|
|
Profit Before Tax
(in crores)
|
75,000,000
|
78,000,000
|
80,000,000
|
84,000,000
|
86,000,000
|
The company proposes to finance the investment with a secured bank loan of 10 crores repayable at the end of the fifth year and carrying an interest of 12% per annum. The bank also charges 2% of the loan amount as service/processing charges. The port authority has approached a financial institution for loan to the tune of 15 crores. The financial institution has agreed to provide 15 crores against secured redeemable debentures of Rs. 100/- face value to be redeemed at the end of the fifth year. It has further proposed that the debentures to be issued at a discount of 5%, redeemable at 5% premium, and carrying 11% interest per annum. The remaining amount of 5 crores is taken from undistributed profits of the firm. The present cost of equity (Ke) for the firm stands at 18%.
The firm is in the tax bracket of 33% and it is estimated to remain same for the next 5 years.
Considering the above information, you are required to suggest the firm on the investment proposal. What would be impact if a tax rate of 40% is considered for the project?