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Capital Budgeting Evaluation Techniques^127

Year PBDT Compo- unding

Factor At 0.15

Revised PBDT

(PBDT X Com.

Fac.)

Depre-

ciation

Taxable

Income

PAT

CFAT

1 70 1.150 80.50 40 40.50 26.32 66.32

2 76 1.322 100.47 40 60.47 39.31 79.31

3 80 1.521 121.68 40 81.68 53.09 93.09

4 60 1.749 104.94 40 64.94 42.21 82.21

5 52 2.011 104.57 40 64.57 41.97 81.97

In an inflationary situation, PBDT are expected to grow at 15 per cent. PBDT can be

determined (reflecting 15 per cent compound rate of growth) using the table. As

amount of depreciation remains unchanged, taxable profits as well as taxes would go

up as exhibited below:

Since CFAT are inflated sums, they are to be deflated at the rate of inflation

(15 per cent) to determine real cash flows. The relevant calculations are as

follows:

Determination of Real Cash Flows

(Amount in thousand rupees)

The real cash flows are substantially lower than nominal cash flows. This is due to the

fact that increased income (as depreciation charges do not change) is subject to higher

amount of taxes. The corporate tax rate is more than twice (35 per cent) the

inflation rate (15 per cent). The NPV and real cash inflows are shown in the following

tables.

NPV Calculations

(Amount in thousand rupees)

Since the NPV is negative under inflationary situations, the investment proposal is not

acceptable. Thus, inflation results both in lower cash flows and lower real rates of

Year CFAT Discount/ deflated factor at 0.15 Real cash inflows (CFAT)

1 66.32 1/1.15 = 0.870 57.50

2 79.31 1/(1.15)^2 = 0.756 59.96

3 93.09 1/(1.15)^3 = 0.658 61.25

4 82.21 1/(1.15)^4 = 0.572 47.02

5 81.97 1/(1.15)^5 = 0.497 40.74

Year Real CF PV factor at 12% Present Value

1 57.70 0.893 51.53

2 59.96 0.797 47.79

3 61.25 0.712 43.61

4 47.02 0.636 29.90

5 40.74 0.567 23.10

195.93

200.00

Gross present value

Less: Cash outflows

Net present value (4.07)