9d3c8Lecture 16 Capital Budgeting

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Amity Business School

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Amity Business SchoolMBA Class of 2013, Semester II

Financial Management

Module IV


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For taxation purposes, depreciation is charged (on the basis

of written down value method) on a block of assets and noton an individual asset.

A block of assets is a group of assets (say, of plant and

machinery) in respect of which the same rate of depreciationis prescribed by the Income-Tax Act.

Treatment of Depreciation


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Block of assets as per the Income Tax Act

Buildings 3 Blocks

5% Depreciation

10% Depreciation 100% Depreciation

Furniture 1 Block

15% Depreciation

Plant & Machinery 7 Blocks

20% Depreciation 25% Depreciation 40% Depreciation 50% Depreciation 60% Depreciation 80% Depreciation 100% Depreciation

Intangible assets 1 Block

25% Depreciation

For the 4 Classesof Assets ,

we have

12 Block of

Assets


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Capital Gain arises in the followingsituations

(i) When the sale proceeds exceeds the WDV ( Written Down Value)of the whole block

(ii) When the entire block is sold out.


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Asset Rate of Depreciation WDV as on 1-4-2008

Plant P 25% 80,000

Plant Q 25% 60,000

Plant R 25% 40,000

Plant S 25% 20,000

2,00,000

Written Down Value of the Block ofassets

P,Q,R,S form asingle Block of

Assets having25%

Depreciation.


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BHEL owns the following assets as on 31.3.09

Asset Rate of Depreciation WDV as on 1-4-2008

Plant P 25% 80,000

Plant Q 25% 60,000

Plant R 25% 40,000

Plant S 25% 20,000

2,00,000

(a) Plant P is sold on 15-3-2009 for Rs. 2,20,000. Compute the Capital Gain/Loss(b) Plant P is sold on 15-3-2009 for Rs. 1,80,000. Compute the Capital Gain/Loss

(c) Plant P,Q,R,S are together sold for Rs. 1,90,000. Compute the Capital Gain/Loss

(d) Plant P,Q,R,S are together sold for Rs. 2,50,000. Compute the Capital Gain/Loss


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Sale Proceeds 2,20,000

Less : WDV of the Block 2,00,000

Capital Gain 20,000

Case (a)


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Case (b)

There will be no Capital Gain, in this case, because the saleconsideration is less than the value of the block.

WDV , on which depreciation is allowable is Rs.20,000(2,00,000 1,80,000)


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Capital Loss 10,000

Case (c)


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Capital Gain 50,000

Case (d)


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X owns two machineries eligible for depreciation at therate of 25%. The WDV of these machines as on1.4.2008 was Rs. 25,000 and Rs. 40,000 respectively.No other asset was acquired in this block during theyear. Both these machines were sold during the year forRs. 60,000. Is there any Capital Gain/ Loss ? If yes,then what amount ?


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Depreciation is charged on the year-end balance of the block which

is equal to

Opening balance of the Block of assets

+ purchases of assets made during the year

(in the block considered)

- sale proceeds of the assets during the year.


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In case the entire block of assets is sold during the year (the blockceases to exist at year-end), no depreciation is charged at the year-end.

If the sale proceeds of the block sold is higher than theopening balance, the difference represents short-term capital

gain which is subject to tax.

Where the sale proceeds are less than the opening balance,the firm is entitled to tax shield on short-term capital loss.

In case an asset falling in a block of assets is sold out ( for an amount that isless than the WDV of the whole Block), there is no Capital Gain. The saleproceeds of the asset are reduced from the WDV (Written down Value) of theblock.

To Summarize


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Treatment of Working Capital inProject Evaluation


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Almost every Investment proposal requires an additional investmentin Working Capital (in some form or the other).

The proposal, if accepted would require increase in minimum CashBalance , higher inventory levels or more receivables.

Any additional investment in working capital cannot be usedelsewhere and is similar to an investment made in building, plant.Machinery etc. It has to be viewed as a cash outflow, when it ismade.

At the end of the proposal , this additional working capital beinginvested now will be released . Thus, any decrease in workingcapital can be treated as a release of working capital or cash inflow.


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Hence, Cash needs for working capital should be treated as a cash

outflow at the time of commencement of a project and should be

treated as inflow when that cash is released at the time of closure or

termination of projects.


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Requirements of Good Method of Project

Evaluation It should be based on cash flows rather than on profits or

expenditures.

Cash flows to be recovered over the entire expected life of the assetrather than few years only.

It should consider the time value of money.

It should indicate relative profitability between different alternatives,

so that a ranking can be made between different proposals.

It should indicate the degree of risk and the chances of getting profitor loss in a given situation.

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9d3c8Lecture 16 Capital Budgeting