Saswat Dairy Ltd. (SDL) is planning to buy dairy plant costing ₹400 lakh. Milk Board provides 10% subsidy on the capital cost. It can process milk to produce cheese with the capacity of 1,800 tonnes per annum. The sellin

CS Professional · Financial, Treasury and Forex Management · PYQS · June 2015
Saswat Dairy Ltd. (SDL) is planning to buy dairy plant costing ₹400 lakh. Milk Board provides 10% subsidy on the capital cost. It can process milk to produce cheese with the capacity of 1,800 tonnes per annum. The selling price of cheese is taken as ₹50 per Kg. The management expects the life of the plant at 8 years and the depreciation shall be computed using straight line method. However, the plant can be sold at ₹50 lakh at the end of its useful life. The utilisation of plant is expected as below: Years 1 2 3 4 to 8 Capacity Utilisation 60% 70% 80% 90% The variable cost constituting primarily of the raw material (milk) is placed at 40% while the fixed expenses are ₹300 lakh per annum. The company pays tax @35%. The additional working capital required is ₹100 lakh. Find the following (e) Should the project be accepted based on NPV and IRR.

Answer & Explanation:

(e) The Net Present Value: The NPV decision rule specifies that all independent projects with a positive NPV should be accepted. Therefore, if the project's NPV is Positive it should be accepted and if it is negative it should be rejected. In this case NPV is positive therefore project may be accepted. Internal Rate of Return: The IRR (internal rate of return) rule is to accept a project if the IRR is higher than opportunity cost of capital. In the present case, the Project may be accepted till the time the cost of capital is less than 16%. In this case, as the cost of capital is less than 16%, therefore the project may be accepted.

Topics: Capital Budgeting

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