Sum 1 A project costs Rs.5,00,000 and has a scrap value of Rs. 1,00,000.

Its stream of income before depreciation and taxes during first year through five years is Rs. 1,00,000, Rs.1,20,000, Rs. 1,40,000, Rs. 1,60,000 and Rs. 2,00,000. Assume a 50 per cent tax rate and depreciation on straight-line basis. Calculate the accounting rate for the project. Also explain the advantages and disadvantages of ARR Particulars PBDT Depreciation (Note 1) PBT Tax @ 50% PAT Average Profit = Year 1 100,000 80,000 20,000 10,000 10,000 32,000 Year 2 120,000 80,000 40,000 20,000 20,000 Year 3 140,000 80,000 60,000 30,000 30,000 Year 4 160,000 80,000 80,000 40,000 40,000 Year 5 200,000 80,000 120,000 60,000 60,000

Accouning Rate of Return (ARR) = Average Annual Profit/Initail Investment ARR = 6%

Note 1: Depreciation Initial Investment Scrap Value Project Life (Years) Depreciation pa = 500,000 100,000 5 80,000

Sum 2 The EBIT of a firm is expected to be Rs 10,000. The firm has to pay interest @5% on debentures worth Rs 25,000. It also has preference shares worth Rs 15,000 carrying a dividend of 8%. Interpret the change in EPS if EBIT is Rs 5,000 and Rs 15,000? Number of outstanding shares is 1000 and take tax rate is 40%. Particulars EBIT Interest @ 5% EBT Tax @ 40% EAT Preference Dividend @ 8% Earnings Available To Equity Share Holders Number of Equity Shares Earnings Per Share (EPS) Current EPS = EPS when EBIT is 5,000 = EPS when EBIT is 15,000 = A) EBIT is Rs 5,000 % decrease in EPS = Amount 10,000 -1,250 8,750 -3,500 5,250 -1,200 4,050 1000 4.05 4.05 1.05 7.05 Amount 5,000 -1,250 3,750 -1,500 2,250 -1,200 1,050 1000 1.05 Amount 15,000 -1,250 13,750 -5,500 8,250 -1,200 7,050 1000 7.05

5,000

74%

Equity share holders are eligible to share residual profit after the fixed obligations of the company are met. Preference share holders have a perferential right of dividend over equity share holders. EPS has declined by 74% when EBIT has declined by 50%. This is because the fixed obligations of the company are to be met before declaring dividend for Equity Share Holders irrespective of the EBIT. B) EBIT is Rs 15,000 % increase in EPS =

74%

Equity share holders are eligible to share residual profit after the fixed obligations of the company are met. Preference share holders have a perferential right of dividend over equity share holders. EPS has increased by 74% when EBIT has increased by 50%. This is because the benefit of surplus EBIT after meeting the fixed obligations of the company is available to Equity Shareholders.

50%