Question
ABC Ltd. is considering the purchase of a machine costing ₹1,50,000. The project requires an additional investment in working capital of ₹20,000, which is recoverable at the end of the project's life. The expected cash flows are as follows:
Year 1: ₹25,000
Year 2: ₹35,000
Year 3: ₹45,000
Year 4: ₹55,000
Year 5: ₹60,000
The machine is expected to have a salvage value of ₹15,000 at the end of Year 5.
Required:
Calculate the Payback Period.
Comment on the project’s liquidity position based on the payback criterion.
a) Dividend policy plays a significant role in determining the market value of equity shares. Discuss the concept of dividend-based share valuation and explain the major models used for valuing equity shares. (10+10)
b) An equity analyst is evaluating the shares of ABC Ltd. The company has recently paid a dividend of ₹6 per share. Dividends are expected to grow at a constant rate of 5% per annum in the future. The required rate of return expected by investors is 15%.
Required:
Calculate the intrinsic value of the equity share using Gordon’s Growth Model.
If the current market price of the share is ₹78, determine whether the share is overvalued or undervalued.
Answer :
Word Count : 1268
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ABC Ltd. is considering an investment in a machine costing ₹1,50,000 along with an additional working capital investment of ₹20,000. Since the working capital is recoverable at the end of the project, the total initial investment for the purpose of calculating the Payback Period is ₹1,70,000. The Payback Period is the time required to recover the initial investment from the cash inflows generated by the project. It is an important capital budgeting technique because it indicates the period for which the funds remain tied up in the project and provides an indication of the project's liquidity and risk. The initial investment is: Machine cost = ₹1,50,000 Working capital investment = ₹20,000 Total initial investment = ₹1,70,000 The expected annual cash inflows are: | Year | Cash Flow (₹) | Cumulative Cash Flow (₹) | | ---- | ------------: | -----------------------: | | 1 | 25,000 | 25,000 | | 2 | 35,000 | 60,000 | | 3 | 45,000 | 1,05,000 | | 4 | 55,000 | 1,60,000 | | 5 | 60,000 | 2,20,000 | At the end of Year 4, cumulative cash inflows are ₹1,60,000. Therefore, ₹10,000 of the initial investment remains unrecovered. Cash flow during Year 5 = ₹60,000 Fraction of Year 5 required to recover ₹10,000: ₹10,000 / ₹60,000 = 0.1667 year Therefore, Payback Period = 4 + 0.1667 = 4.17 years approximately. Thus, the Payback Period is approximately 4 years and 2 months. The salvage value of ₹15,000 and recovery of working capital of ₹20,000 will be received __________ ______ _______ __________ ______.
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