libdoc_21

8/12/2019 libdoc_21

1/19

Page 1Risk Analysis and Insurance Planning (RAIP) Numerical

Risk Analysis & Insurance Planning (RAIP)

All numericals solved herein below are taken from FPSB India's "Sample Paper - Exam 1:- Risk Analysis & Insurance Planning" uploaded on their

website.

Section II; Q#6

A training institute bought 50 computers at a total cost installed for Rs. 25 Lakhs. The set up came into operation on 1st April, 2012. The cost of a

similar new computer in due course declined to Rs. 42,000. The industry norm of the depreciation charged on the computers is 30% on Written

Down Value (WDV) basis. At what appropriate value he should insure the set up on next due date - 1st April, 2013?

Ans: -

Particulars Rs.

Current Replacement Cost 2,100,000

(-) Depreciation @ 30% 630,000

Value to be insured 1,470,000

Current Scenario:-

1st April, 2012: - 50 computers were bought at Rs. 25,00,000

(i.e. Rs. 50,000 per computer). The said computers have been

used for 1 year (1st April 2012 - 31st March, 2013) &

depreciation to the extent of 30% has been charged on WDV

basis. The current cost (i.e. on 1st April, 2013) for buying one

computer is Rs. 42,000 (it has fallen down from Rs. 50,000 - as

on 1st April, 2012). Thus for buying 50 computers today (i.e. 1st

April, 2013), it will cost us Rs. 42,000 x 50 = Rs. 21,00,000.

Note: - Depreciation at 30% needs to be deducted from the

Current Replacement Cost in lines with the "Principle of

Indemnity" which states that - "The insured should be placed in

the same position as he was prior to the occurance of the loss."

The said computers have already been used for a period of 1 year

& the computers have been accordingly depreciated. If there is

any loss that occurs, the insured should be compensated

accordingly - not allowing him to "profit" from the situation.

8/12/2019 libdoc_21

2/19


Section II; Q#7

A with profit life insurance policy with a track record of offering bonuses at Rs. 50/1000 sum assured (SA)has a premium differential of Rs.

30/1000 SA from a pure term policy. The pure term cover of 20 years & SA Rs. 12,00,000 is available at Rs. 7,860 p.a. If the loyalty addition is

expected on the 20 year with profit policy is Rs. 235/1000 SA, you evaluate both policies from the perspective of 8% p.a. return on surviving the

term. You find that _____________

Ans: -

Let us first understand what is "Premium Differential".Premium Differential is nothing but the difference in the amount of premium paid on

two policies. In this case, the concerned prospect, has bought two policies - (1) A with profit policy (it could either be a "whole life policy" or an

"endowment policy" or a "money back policy") & (2) A term insurance policy. You'd agree when I say, that, the premium paid under the "with

profit policy" would be more in comparison to the "term insurance policy" (A term insurance is a "pure risk" cover & covers only the risk of

death. It has no "savings element" - as under "whole life", "endowment" or "money back'). So, assuming all other things remain constant (i.e.

period, sum assured etc), the reason of a "premium differential" between the "with profit policy" & the "term insurance policy" is on account of

the "savings element" available with the "with profit policy".Also note that - there could also be a "premium differential" for two individuals on

a same policy with the same sum assured - on account of age, sex, hobbies, health, habits - smoker or non smoker etc. So, it need not be that,

the "premium differential" has to be between two different policies (as in the above case).

Particulars TermWith Profit

Policy

Bonus & loyalty additions (if any) Not Available Available

Savings element Not Available Available

Sum assured to be received on

surving the termNot Available Available

Sum assured paid on death Available Available

Quick Review between a "term insurance" policy & a "with profit"

policy

Current Scenario: -

Term Insurance

Period of the cover = 20 years (given)

Sum assured (SA) = Rs. 12,00,000 (given)

Premium = Rs. 7,860 p.a. (given)

With Profit policy

Bonus = Rs. 50/1000 SA (given) (i.e. 50/1000 x 12,00,000 = Rs.

60,000 x 20 years = Rs. 12,00,000)Premium differential = Rs. 30/1000 SA (given) (i.e. Rs. 30/1000 x

12,00,000 = Rs. 36,000)

Loyalty additions = Rs. 235/1000 SA (given) (i.e. Rs. 235/1000 x

12,00,000 = Rs. 2,82,000)

Period of the cover = 20 years (given); Sum assured (SA) = Rs.

12,00,000 (same as the term insurance cover)

Notethat, they have asked in the problem to evaluate both the

policies from the perspective of 8% p.a. return on the assumption that

the concerned prospect "survives the term". On surving the term, the

prospect, under the "with profit policy" would receive -

(1) The maturity proceeds (i.e. sum assured); (2) Bonus & (3) Loyalty

additions

8/12/2019 libdoc_21

3/19


Total amount received on maturity under "with profit

policy"

Particulars Rs

Maturity proceeds3 1,200,000

Bonus 1,200,000

Loyalty additions 282,000

Total 2,682,000

Set Begin1

n 20

i% = ? = Solve 11%

PV(1) 0

2PMT = -36000

FV(20)= 2682000

P/Y & C/Y 1

Now, we've to first evaluate the return that the prospect has earned by investing in

the "with profit" policy (before we compare the same with the prescribed rate of

return of 8%p.a)

CMPD mode Notes: -

1. Ins. premiums are always paid at

the "beginning" of the period.

2. The "premium differential" of Rs.

36,000 is taken into perspective to

evaluate the "net return" earned by

investing in a with profit policy vis a

vis a "term insurance" policy.

3. According to FPSB India's solutions

the said maturity proceeds of Rs.

12,00,000 isn't taken into

consideration - we feel that the same

needs to be taken into consideration

as the prospect would receive the

amount on maturity. The issue has

been brought to the notice of FPSB

India & awaiting their response.

Thus the prospect is paying Rs. 36,000 (i.e. premium

differential) extra , in a "with profit" policy to receive

Rs. 26,82,000 on surviving the term (which wouldn't

have been received in a "term insurance" policy)

Thus, the return differential on survivingthe term is: - 11 - 8 = 3% (Final Answer).

8/12/2019 libdoc_21

4/19


Section II; Q#8

Mr. A has a gross annual salary of Rs. 10,00,000 of which he saves 25% including mandatory savings & voluntary systematic investments.

Another 35% goes towards servicing of housing & car loans & taxes. His financial planner advises him to accumulate 8 months household

expenses in liquid funds. Mr. A changes his job & expects an immediate rise of 30% in his gross income. The incremental effect in his mandatory

savings & taxes would respectively be 1.5% & 3% of his revised gross income. You estimate that other heads would not change materially except

his household expenses which would rise by 8% due to child education. How many months will it take to accumulate the liquid reserves?

Ans: -

Let us first understand the problem & what we are supposed to calculate - Mr. A is earning Rs. X as salary as is incurring some expeneses, say Rs.

Y. The financial planner has asked Mr. A to "accumulate 8 months household expenses in liquid funds" (a prudent measure under "contingency

reserves" policy). Moreover, we've to find out , the "no. of months" that Mr. A will take to accumulate the liquid reserves after meeting all the

expenses.

Present situation of Mr. A (before change

of job)Rs

Gross Annual Salary 1000000(-) Savings @ 25% (mandatory & voluntary

investments)250000

(-) Housing, Car Loans & Taxes @ 35% 350000

Balance

(household expenses)400000

Situation of Mr. A after the new job Rs

New Salary 1300000 [10,00,000 + (10,00,000*30%)][2,50,000 + (13,00,000*1.5%)]

[3,50,000 + (13,00,000*3%)]

[4,00,000 + (4,00,000*8%)]

(-) Savings 269500

(-) Taxes, housing & car loans 389000

(-) Household expenses1 432000

Balance available to accumulate the

liquid reserves209500

Notes: -

1. Savings & taxes are increasing by 1.5% % 3% overthe "revised gross income". However, the household

expenses are expected to rise by 8% (it hasn't been

mentioned that the same is on "revised gross

income". So it's directly calculated on the old

household expense of Rs. 4,00,000

- 8 months household expenses = Rs. 4,32,000 x (8/12) = Rs. 2,88,000.

- Therefore, no. of years to accumulate the liquid reserves = Rs. 2,88,000 / Rs.

2,09,500 = 1.374701671

- Therefore, no. of months = 1.374701671 x 12 months = 16.49642005 months

8/12/2019 libdoc_21

5/19


Section II; Q#9

A businessman bought a piece of land in March, 2002 for Rs. 80,00,000. He got a factory built on the land at a cost of Rs. 90,00,000, the factory

became operational on 1st September, 2005. The land prices have appreciated at 15% p.a. in the period & the construction cost has escalated at

12% p.a. since 2005. At what value the factory should be insured in April, 2013 on Market Value basis if the depreciation on factory premises is

charged at 6% p.a. on straight line method (SLM)?

Ans: -

Current market value of the factory (which will be insured) taking into consideration a depreciation of 6% p.a. on SLM basis.

Set Begin PV(2005) -9000000FV(2013)

= ? =

Solve22,283,668.59

n (2008 to

2013)8

PMT 0

P/Y 1

i% 12% C/Y 1

Set 365 Explaination

Dys 2920 (8 years*365 days)

i% -6 (Dep rate)

PV(22,283,668.59)

(Revised factory value as on

2013)

SFV = ? 11,587,507.67(Market value of the factory to

be insured)

Particulars Rs.

Current market value of the factory22,283,668.59

(-) Dep @ 6% (SLM basis) for 8 years

(22,283,669 x 6%) x 8 years 10,696,160.92

Market value to be insured11,587,507.67

Method 2: - Logical Method

Current Scenario: -

Cost of land (March' 2002) - Rs. 80,00,000

Cost of factory (Sept' 2005) - Rs. 90,00,000

Escalation of land prices - 15% p.a.

Escalation of construction cost - 12% p.a.

Current date - April' 2013

Revised Factory Value (2013) after escalation of 12% p.a.

Method 1: - SMPL function

Notes: -

1) Although the cost of land has escalated too (to the tune of 15% p.a.), the same isn't taken into consideration because: -

a) Land is a "non-depreciable" & "non insurable" asset

b) The problem has asked us to calculate the amount at which the factory has to be insured.

2) We used the "SMPL function" to calculate the requisite values because the problem states that rate of depreciation is 6% p.a. on "SLM"basis. If

it would have been 6% p.a. on "WDV" basis then we would have used the "CMPD function".

3) Moreover, the given rate of 6% is the "depreciation rate" (and not the interest rate), therefore, we need to insert "-6" in the i% section. The

said amount needs to be "reduced" on the account of depreciation & not increased!

8/12/2019 libdoc_21

6/19


Section III; Q#4

An executive purchased an annuity for a lumpsum Rs. 85,00,000 when he was 53 years old & had in dependents a non-working spouse of age 48

& a son of age 25. On reaching 60, he expects at least one, himself or his spouse, to survive till 85 years & contracts an immediate annutiy with

return of purchase price at Rs. 10,15,000 p.a. vested againts the purchase price of Rs. 1,61,00,000. What return is expected from the vesting

date?

Ans: -

Let us first understand the problem - Mr. Executive has taken an "immediate annuity" (i.e. the annuity begins immediately on the vesting date)

by paying Rs. 1,61,00,000. He'll receive an annuity of Rs. 10,15,000 p.a. Moreover, he has also taken a "return of purchase price" option [i.e.

whatever amount he has paid to purchase the annuity (i.e. in this case Rs. 1,61,00,000)] would be returned back to the executive or the

nominee, as the case may be, after the completion of the said period.

Set Begin

n(1)

30

i% = ? 6.73%

PV(60)(2)

-16100000

PMT(3)

1015000

FV(85)(4)

16100000

P/Y 1

C/Y 1

CMPD function: - Notes: -

(1) The number of years that has to be taken , will depend upon the highest survival period

from the vesting date to the life expectancy. Here Ms. Executive have a life the expectancy

of 30 years from the vesting date (which is higher than Mr. Executive's - 25 years). Although

some of you may argue that the survival of the son is the highest, annuity can be purchased

on the basis of age of the annuitant or his/her spouse as the case may be.

(2) PV = Amount paid to purchase the annuity. Since amount is "paid", its denoted with a -ve

sign.

(3) PMT = Amount "received" every year as an annuity. Since amount is "received", its

denoted with a + ve sign.

(4) FV = Return of purchase price. Since the purchase price paid for the annuity is received

back, we denote the same with a +ve sign.

Vesting Date Life Expectancy

|----------------------------------------------------------------------|---------------------------------------------------------------------|

Mr. Executive 53 60 85

Ms. Executive 48 55 85

Son 25 32

8/12/2019 libdoc_21

7/19


Section III; Q#5

Mr. A has invested in an instrument for 3 years. The instrument has produced a return of 11%, 15% & 12% in the 3 years. You as Mr. A's advisor

have observed that the ruling inflation in these 3 years respectively was 4% , 7% & 8%. You find the real rate of return which Mr. A has received

as___________________

Ans: -

Years

Return

(%)

Inflation

(%) Real Rate (%)

Yr.1 11 4 6.730769231

Yr.2 15 7 7.476635514

Yr.3 12 8 3.703703704

Real Rate of Return = { [ (1 + r) / (1 + i) ] -1 } x 100

Where: -

r = Rate of return; i = Inflation rate

Method 1: -Calculate the "Future Value" of Re. 1

for 3 years

Yr. 1

Set Begin

n 1

i% 6.73%

PV(0) -1

PMT 0

FV(1)= ? 1.067307692

P/Y 1

C/Y 1

Yr. 2

Set Begin

n 1

i% = ? 7.48%

PV(1) -1.06731

PMT 0

FV(2)=

?1.147106

P/Y 1

C/Y 1

Yr. 3

Set Begin

n 1

i% = ? 3.70%

PV(1) -1.1471064

PMT 0

FV(3)= ? 1.18959182

P/Y 1

C/Y 1

CAGR for 3 years

Set Begin

n 3

i% = ? 5.96%

PV(0) -1

PMT 0

FV(3) 1.189592

P/Y 1

C/Y 1

Notes: -

(1) The Future Value of the f irst year becomes the Present Value of the next year.

(2) We've calculated the Future Values of all the years taking into consideration the Real Rate of Return

(3) After calculating the FV(3), we calculated the "compounded annual growth rate (CAGR)" thus giving us the answer of 5.96%

8/12/2019 libdoc_21

8/19


Method 2: -Calculate the "compounded annual growth rate - geometric mean" for the requisite period

YearsReturns

(Real Rate) (%)

Real Rate in

decimals

Relative

Return

(RR)

1 6.730769231 0.067307692 1.067308

2 7.476635514 0.074766355 1.074766

3 3.703703704 0.037037037 1.037037

CWI = RR1 x RR2xRR3x RRn

CWI = (1.067308 x 1.074766 x 1.037037) = 1.1895918

GM = [(CWI)1/n

- 1] x 100 = [(1.1895918)(1/3)

- 1] x 100 =

5.95773205%

8/12/2019 libdoc_21

9/19


Section III; Q#6

A family's monthly expenditure is Rs. 40,000. The earner accounts for 15% of the expense. He wants to cover his family's inflation adjusted

expenses for the next 40 years considering average inflation at 5.5% p.a. & the investment return at 7.5% p.a. The approximate life insurance

needed is___________________

Ans: - Rate of return p.a. 7.50%

Inflation rate p.a. 5.50%

Real rate of return p.a. 1.895735

Amount of life insurance needed

Set Begin

n 40

i% 1.90%

PV(1)= ? 11,484,273.30

PMT 34000

FV(40) 0

P/Y2 12

C/Y 1

Monthly Expenditure 40000

(-) Personal expenditure @15%

1

6000

Net of personal expenditure 34000

Notes: -

1) Personal expenditure of the earner

should be deducted & the net of

personal expenses should be considered

for calculating the life insurance

required.

2) The expenditure of Rs. 40,000 are

"monthly" & so we input 12 in the P/Y

function.


Where: -


8/12/2019 libdoc_21

10/19


Section III; Q#7

A single mother, aged 33, earns Rs. 7,50,000 p.a. out of which taxes a self expenses account for Rs. 1,50,000 p.a. Her salary is expected to rise by

10% p.a. whereas taxes & personal expenses are likely to rise by 6% p.a. If she expects to work till 58 years, what economic value can you

enumerate on her life, if she is confident of getting a return of 9% p.a. from investments?

Ans: -

Present Value of Salary

Set Begin

n 25

i% -0.9090909%

PV(1)=? -20967027.22

PMT 750000FV(58) 0

P/Y 1

C/Y 1

Current Scenario: -

Current Age = 33

Age of retirement = 58

Yrs. left for retirement = 58-33 = 25

Current Salary = Rs. 7,50,000 p.a.

Current taxes & self exp = Rs.

1,50,000 p.a.

Growth in salary = 10% p.a.

Growth in taxes & personal exp =

6% p.

Rate of return = 9% p.a.

What are we supposed to calculate? - We are supposed to calculate the "economic value"

(i.e. Present Value) of her life. (i.e. PV of Salary - PV of exp)

Particulars Rate of growth Rate of Invst. Real Rate of Return (%)

Salary 0.1 0.09 -0.909090909

Taxes & personal

exp0.06 0.09 2.830188679


Where: -


Therefore, the Economic Value of the prospect is =

PV (salary) - PV (taxes & personal exp) = 20,967,027 -

2,737,432= Rs. 18,229,595

Present Value of Expenses

Set Begin

n 25

i% 2.8301887%

PV(1)=? 2737431.68

PMT -150000FV(58) 0

P/Y 1

C/Y 1

8/12/2019 libdoc_21

11/19


Section III; Q#8

Mr. A had taken a loan of Rs.40,00,000 in July' 2010 at a floating rate of interest of 10% p.a. for a tenure of 20 years from a housing finance

company. The company sent a notice raising the interest rate to 10.75% p.a. effective Jan'2012 thereby increasing the EMI. He decides to

refinance the loan at 10.25% p.a. from a bank which charges a processing fee of 1% of loan sanctioned. What absolute amount he stands to save

in the remaining tenure if the outstanding loan amount as at the end of March 2012 is refinanced so that the new loan terminates as per original

tenure?

Ans: -Current Scenario: -

Amount of loan = Rs. 40,00,000

Date of applying for the loan = July 2010

Rate of interest = 10% p.a. (floating rate)

Tenure of the loan = 20 years (i.e. 20 x 12 months = 240 months)

Date of increasing the interest rate = Jan 2012 (i.e. he has paid an EMI at 10% p.a. from July 2010 to

Dec 2011 - 18 months)

New interest rate = 10.75% p.a. (the date of refinancing of the loan is "end" of March 2012. That

means, he has paid a new EMI at 10.75% p.a. from Jan' 2012 to March 2012 - 3 months)

Refinanced int rate = 10.25% p.a.

Processing charges = 1% of loan sanctioned

Date of refinancing the loan = "end" of March 2012

What are we supposed to find out: -How much Mr. A has saved by refinancing the loan

Let us first calculate the EMI at a given

interest rate of 10% p.a.

Set1 End

n 240

i% 10%

PV 4000000

PMT = ? -38600.8658

FV 0

P/Y2 12

C/Y3 12

Notes: -

1) Payments towards an EMI is always & always made at the "end" of the period .

2) Since there will be 12 payments (EMI) in a year, P/Y will be denoted as 12.3) In case of numericals on "loans", even if the problem is silent, the rate of

interest is always compounded monthly, thus C/Y = 12

Rule of thumb for numericals on "loans" / "borrowings" etc

a) Use the "end" function even if the problem is silent

b) C/Y = 12 (compounding will always take place monthly - even if the problem is

silent)

8/12/2019 libdoc_21

12/19


Now let us calculate the

"outstanding loan" amount on

Jan'2012 (i.e. when the new rate

change has been made effective)

(Mr. A has paid an EMI of Rs.

38,600.8658 from July' 2010 to Dec'

2011 - i.e. for 18 months)

Set End PMT -38600.866

PM1 1 FV 0

PM2 18 P/Y 12n 240 C/Y 12

i% 10 Bal = Solve 3898160.27

PV 4000000

Therefore the O/S loan amount as

on 1st Jan' 2012 (i.e. the date of

rate change) is Rs. 38,98,160.269

AMRT function

Let us now calculate the new EMI at a

given interest rate of 10.75% p.a.

Set End

n = 240-18 222

i% 10.75%

PV(19) 3898160.269

PMT = ? -40515.5594

FV(222) 0

P/Y 12

C/Y 12

Set End PMT -40515.559

PM1 1 FV 0

PM2 3 P/Y 12

n 222 C/Y 12

i% 10.75 Bal = Solve 3881225.85

PV 3898160.269

Therefore the O/S loan amount

as on 31st March' 2012 (i.e.

when Mr. A opted for

refinancing) is Rs. 38,81,226

Now, the O/S Loan for refinancing (as on 1st April, 2012) = Rs. 38,81,226

Balance period of the loan = 240 - 18 - 3 = 219 months

New rate of interest (on refinancing) = 10.25% p.a.

Processing fee = 1% of loan sanctioned (i.e. Rs. 38,81,226)

Now, Mr. A has paid the new EMI of Rs. 40,515.5594 for 3 months (i.e. Jan 2012 to March 2012)

before opting for refinancing of the loan. So let us now calculate the outstanding loan amountwhich has been refinanced

AMRT Function

8/12/2019 libdoc_21

13/19


Let us now calculate the new EMI

at a given refinanced interest rate

of 10.25% p.a.

Set End

n = 240-18 -3 219i% 10.25%

PV(23) 3881226

PMT = ? -39245.18156

FV(222) 0

P/Y 12

C/Y 12

Total cash outflow post refinancing: -

Payment of loans (Rs. 39,245 x 219) = Rs. 85,94,655

(+) Processing fee of 1% of Rs. 38,81,226 = Rs. 38,812.26

Therefore, total cash outflow = Rs. 86,33,467

If Mr. A wouldn't have opted for refinancing, then: -

Payment of loans (Rs. 40,516 x 219) = Rs. 88,73,004

Therefore, absolute amount saved on account of refinancing:

Rs. 88,73,004 - Rs. 86,33,467 = Rs.2,39,537 (Final Answer)

Notes: -

Kindly note that, "processing fees" need to be added seperately & shouldn't be

added to the O/S loan amount of Rs. 38,81,226 - which is used to calculate the

"new EMI post refinancing" (i.e. Rs. 39,245)

8/12/2019 libdoc_21

14/19


Section III; Q#9

A company has a retirement age as 58 years. An employee at age 35 expected increments of 7% p.a. as per company policy when his annual net

earnings were Rs. 6,00,000. After 5 years, he got next cadre and his annual net earnings became Rs. 9,00,000. The increments in the revised

cadre are at 9% p.a. He had purchased a life cover by income replacement method at age 35. What additional cover is required if he expects his

investments to yield 9.5% p.a.

Ans:-

Current Scenario: -

At age 35

Current Age = 35



Annual net earnings = Rs. 6,00,000 p.a.

Expected increments = 7% p.a.

Expected yield = 9.5% p.a.

At age 40 (after 5 years)

Current Age = 40



Annual net earnings = Rs. 9,00,000 p.a.

Expected increments = 9% p.a.

Expected yield = 9.5% p.a. Age

Exp.

Increments

(%)

Expected

Yield (%)

Real Rate of

Return (%)

Age 35 7 9.5 2.336448598

Age 40 9 9.5 0.458715596

The employee has purchased an insurance cover at the age of 35 by the "income

replacement method" (i.e. human life value - HLV method). At age 40, he wants to

know the additional amount of life insurance cover required


Where: -


Life insurance, under the HLV method is calculated as -

PV(Income lost) . Let us now calculate the PV of income lost, both at the age of 35 &

40 for us to f ind out the extra amount of life insurance required

8/12/2019 libdoc_21

15/19


Present Value of "net annual

income lost" at age 35

Present Value of "net annual

income lost" at age 40

Set Begin

n = 58-35 23

i% 2.336448598%

PV(35)= ? -10830034.76

PMT 600000

FV(58) 0

P/Y 1

C/Y 1

Set Begin

n = 58-

4018

i% 0.458715596%

PV(35)=

?-15586286.44

PMT 900000

FV(58) 0

P/Y 1

C/Y 1

Therefore, extra insurance cover required: -

Insurance amount required (at age 40) = Rs.

1,55,86,286.44

(-) Insurance already purchased (at age 35) =

Rs. 1,08,30,034.76

Therefore, extra insurance required = Rs.

1,55,86,286.44 - Rs. 1,08,30,034.76 = Rs.

47,56,251.68

8/12/2019 libdoc_21

16/19

8/12/2019 libdoc_21

17/19


Section IV; Q#7

An entrepreneur setting up a leather processing unit purchased a land in 2006 for Rs. 50,00,000 and got specialized construction done in 2007

for Rs. 1.6 crore. In March 2008, the processing plant was constructed at a cost of Rs. 2 crore. The cost of such construction & plant are

escalating at 10% p.a. The corrosive nature of chemicals requires depreciation on plant as well as premises at 15% p.a. on written down value

basis (WDV). As in 2013 what additional reserves should be created by the company apart from depreciation reserves & residual insured value of

plant & premises to reinstate the facility in case it is destroyed in a calamity?

Ans:-

Current Scenario: -

Cost of land (2006) - Rs. 50,00,000

Cost of construction (2007) (premises) - Rs.

1,60,00,000

Cost of processing plant (2008) - Rs.

2,00,00,000

Escalation (inflation) for both plant &

construction (i.e. premises) - 10% p.a.

Dep. rate - 15% p.a. (WDV)Date at which additional reserves need to

be calculated2013

To calculate: -

What "additional reserves" should be

created by the company apart from

depreciation reserves & residual insured

value of plant & premises to reinstate the

facility in case it is destroyed in a calamity?

i.e. Additional reserves = Reinstatement

value (-) Dep. Reserves (-) Residual value

of plant & premises

So let us start of by calculating the

required fields one by one.

Cost of construction (premises) as on

2013:-

CMPD function

Set = Begin

n = 2013 - 2007 = 6

i% = 10 (escalation)

PV(2007)= -1,60,00,000

PMT = 0FV(2013)= ? = 2,83,44,976

P/Y = 1

C/Y = 1

Cost of plant as on 2013:-

CMPD function

Set = Begin

n = 2013 - 2008 = 5

i% = 10 (escalation)

PV(2008)= -2,00,00,000

PMT = 0

FV(2013)= ? = 3,22,10,200

P/Y = 1

C/Y = 1

8/12/2019 libdoc_21

18/19


Therefore, the "reinstatement value" if the company was destroyed by a calamity today will be = Rs. 2,83,44,976 + Rs.

3,22,10,200 = Rs. 6,05,55,176 (FV of premises + FV of plant)

Let us now calculate the total amount of

depreciation on premises using the"CMPD" mode

Depreciation rate

Residual insurance valueof premises

Let us now calculate the total

amount of depreciation on plantusing the "CMPD" mode

Set Begin

n = 2013 -

20085

i% -15%

PV(2007) -20000000

PMT 0

FV(2013) 8874106.25

P/Y 1

C/Y 1

Therefore total depreciation on

plant= Rs. 2,00,00,000 - Rs.

88,74,106.25 = Rs. 1,11,25,893.75

Therefore, total amount of depreciation on plant & premises = Rs. 1,11,25,894 + Rs. 99,65,608 = Rs. 2,10,91,502Total residual insured value of plant & premises = Rs. 88,74,106 + Rs. 60,34,392 = Rs. 1,49,08,498

Therefore, the "additional reserves"required is = Rs. 6,05,55,176 (-) Rs. 2,10,91,502 (-) Rs. 1,49,08,498 = Rs. 2,45,55,176

Therefore total depreciation on

premises = Rs. 1,60,00,000 - Rs.

60,34,392.25 = Rs. 99,65,607.75

Residual

insurance valueof plant

Set Begin

n = 2013 -

20076

i% -15%

PV(2007) -16000000

PMT 0

FV(2013) 6034392.25

P/Y 1

C/Y 1

8/12/2019 libdoc_21

19/19


Those of you, who haven't understood the calculation of the "residual insurance value" & "total depreciation" on plant & premises

calculated above in the CMPD function, can have a look at the logical calculation shown herein below

Residual Value & total depreciation on premises

Years Op. Balance

(a)

Dep @ 15% (WDV)

(b) = (a) x 15%

Cl. Balance

(c ) = (a - b)

2007 16,000,000 2,400,000 13,600,0002008 13,600,000 2,040,000 11,560,000

2009 11,560,000 1,734,000 9,826,000

2010 9,826,000 1,473,900 8,352,100

2011 8,352,100 1,252,815 7,099,285

2012 7,099,285 1,064,893 6,034,392

TOTAL DEPRECIATION 9,965,608

Residual Value & total depreciation on plant

Years Op. Balance

(a)

Dep @ 15% (WDV)

(b) = (a) x 15%

Cl. Balance

(c ) = (a - b)

2008 20,000,000 3,000,000 17,000,000

2009 17,000,000 2,550,000 14,450,000

2010 14,450,000 2,167,500 12,282,500

2011 12,282,500 1,842,375 10,440,125

2012 10,440,125 1,566,019 8,874,106

TOTAL DEPRECIATION 11,125,894

Residual insurance value of premises

Residual insurance value of plant

Documents

libdoc_21