Page 127 - DMGT409Basic Financial Management

Basic Financial Management

Notes Illustration 5: The working result of two machines are given below

Machine X ` Machine Y `
Cost 45,000 45,000
Sales per year 1,00,000 80,000
Total Cost Per Year 36,000 30,000
(excluding depreciation)
Expected Life 2 years 3 years

Which of the two should be preferred?
Solution:
Computation of average income

Machine X ` Machine Y `
Sales per year 1,00,000 80,000
Less: cost per year 36,000 30,000
64,000 50,000
Less: Depreciation 22,500 15,000
Net profi t 41,500 35,000
Average Income 41,500 35,000
Average Investment 22,500 22,500
AverageIncome
ARR = × 100
Averageinvestment

41,500
For' ' × 100 = 184%
X
22,500
35,000
For' ' = × 100 = 156%
Y
22,500
Machine X has higher ARR. Hence, Machine X should be preferred.
Working Notes:
Calculation of Depreciation
Depreciation = Original Cost – Scrap value / life of assets in years
For Machine X
Depreciation = ` 45000-0/2 year = ` 22500

For Machine Y
Depreciation = ` 45000 -0/3 years = ` 15000

Illustration 6: A limited firm has under consideration the following two projects. Their details
are as follows:
Project X ` Project Y `
Investment in machinery 10,00,000 15,00,000
Working capital 5,00,000 5,00,000
Life of machinery (Years) 4 6
Scrap value of machinery (%) 10 10
Tax rate (%) 50 50

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