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Capital Budgeting 127
Proposal I
Proposal II
Automatic Machine
Ordinary Machine
Cost of the machine Rs. 2,20,000 Rs. 60,000
Estimated life 5½ years 8 years
Estimated sales p.a. Rs. 1,50,000 Rs. 1,50,000
Costs : Material 50,000 50,000
Labour 12,000 60,000
Variable Overheads 24,000 20,000
Compute the profitability of the proposals under the return on investment method.
(M.Com., Madras and Bharathidasan)
Solution
Profitability Statement
Automatic
Ordinary
Machine Machine
Cost of the machine Rs. 2,20,000 Rs. 60,000
Life of the machine 5½ years 8 years
Rs.
Rs.
Estimated Sales (A) 1,50,000 1,50,000
Less : Cost : Material 50,000 50,000
Labour 12,000 60,000
Variable overheads 24,000 20,000
Depreciation (1) 40,000 7,000
Total Cost (B) 1,26,000 1,37,000
Profit (A) – (B) 24,000 12,500
Working:
(1) Depreciation = Cost ÷ Life
Automatic machine = 2,20,000 ÷ 5½ = 40,000
Ordinary machine = 60,000 ÷ 8 = 7,500
Return on investment =
Average profit
Original investment
=
× 100
24,000
2,20,000 × 100 12,500
60,000 × 100
10.9% 20.8%
Automatic machine is more profitable than the ordinary machine.