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CA Final · Advanced Financial Management · Financial Policy and Corporate Strategy

Surya Engineering Ltd has an EBIT of Rs 60 lakh and is all-equity financed with a cost of equity of 15%. It is evaluating a project with a perpetual after-tax operating cash flow of Rs 18 lakh per year, requiring an investment of Rs 100 lakh, financed fully by equity at the same 15% required return. What is the project's NPV and the resulting decision under the value-maximisation objective?

The perpetual inflow of Rs 18 lakh capitalised at 15% gives a present value of Rs 120 lakh. Deducting the Rs 100 lakh investment gives an NPV of Rs 20 lakh. Since it is positive and increases shareholder wealth, the project should be accepted.

  1. ANPV of Rs 20 lakh; accept the projectCorrect
  2. BNPV of negative Rs 20 lakh; reject the project
  3. CNPV of Rs 18 lakh; accept the project
  4. DNPV of Rs 120 lakh; accept the project

Explanation

PV of perpetuity = 18/0.15 = Rs 120 lakh. NPV = 120 - 100 = Rs 20 lakh, positive, so accept. Rs 120 lakh is the present value, not the NPV, because the outlay was not deducted. The Rs 18 lakh figure is just the annual inflow.

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