UNIT -1 (contd)

CREDIT APPRAISAL Part I -Term Loans

Topics covered
1. 2. 3. 4.

Sources of finance long term Term loans features Project appraisal Lending norms and policies of banks

Sources of finance long term



Shares
 Equity

& retained earnings  Preference

    

Debentures / bonds Lease financing Deferred credit Term loans Foreign sources GDRs/ADRs, Foreign bonds and foreign currency loans

EQUITY SHARES -FEATURES

   

Ownership securities Right to control - Voting rights Right to residual profits Right in liquidation residual claim over assets Returns in the form of dividends and capital appreciation Riskier than debt instruments

EQUITY SHARES


Advantages to investor * Higher returns expected than debt * Dividends tax free in hands of investor * Liquidity - traded in stock exchange * Wealth sharing Disadvantages to investor * Higher risk * Not obligatory for issuer to pay dividends

EQUITY SHARES


Advantages issuer * Dividend payment not mandatory, but there is dividend tax on payouts * Permanent capital - no repayment obligation (until liquidation) * Higher equity means better borrowing ability trading on equity Disadvantages - issuer * Costlier source of funds than debt * Dilution in control * Dividends not tax deductible (unlike interest)

RETAINED EARNINGS


  

Readily available internally (internal equity) No issue costs No dilution in control Reflects the robustness of company s health and reduces dependance on outside funding The only point to be remembered is retained earnings also has a cost in terms of opportunity cost to investors

PREFERENCE SHARES
 

  

Preference over equity shareholders in payment of dividends and in repayment of capital While their claim is above equity shareholders, it is subordinate to the claims of all other stakeholders Preference dividend generally paid as a fixed % of face value of shares No voting rights except in matters which concern them Types of preference sharessharesredeemable,irredeemable, participating,nonparticipating,nonparticipating, cumulative,non- cum. cumulative,non-

PREFERENCE SHARES (contd)



Advantages to investor :
 

Lesser risk than in equities No tax on dividends Lesser returns than equities Less liquid than equities Lesser cost of capital Dividend payment not obligatory No loss of control Dividends not tax deductible for issuer

Disadvantages to investor:
 

Advantages to issuer :
  

Disadvantages to issuer :


DEBENTURES / BONDS
     

Debt instrument bearing Face value, coupon rate of interest, maturity period Interest to be paid every year at coupon rate Redemption on maturity Redemption value at par, at premium,at discount Generally market price is at a discount to face value Yield (return w.r.t market price) inversely related to market price Current yield/ Yield to maturity (YTM )

DEBENTURES


Advantage to investor


Lesser risk than equities (though lesser return) Lower cost of funds Interest is tax deductible No loss of control Interest payment mandatory Redemption cash outflows Increases financial risk

Advantages to issuer :
  

Disadvantages to issuer :
  

Types of debentures
 

Non convertible not convertible to equity shares Partly convertible part of face value of debenture converted to equity at predetermined price, balance as debenture with interest payable Fully convertible entire face value of debenture converted into equity shares Zero coupon bonds no interim interest payment, issued at discount to face value, redeemed at par, difference represents discount treated as capital gains also called deep discount bond

CONVERTIBLE DEBENTURES


Conversion to equity after a point of time at a predetermined rate The debenture will earn interest on face value until conversion after which it will earn dividends and capital appreciation If partly convertible then only a part of the face value is converted to equity and balance continues to earn interest

Advantages of conv. debentures

 

No redemption cash outflows Lower interest payments initially and higher dividends to investors later Shown as debt until conversion after which it is shown under equity ( better debt equity ratios) To the investor , fixed interest initially, possibility of profit and wealth sharing later

DEFERRED CREDIT


Suppliers of equipment allow buyer to pay in instalments spread over several years. The period over which instalments are spread over & finance charges depend on
  

Credit standing of the buyer Value of equipment Demand for the equipment in the market

LEASE FINANCING


  

 

A contractual arrangement where the lessor grants the lessee the right to use an asset in return for periodical lease rental payments Asset reverts to lessor at the end Operating lease vs. finance lease Lease rentals payable by lessee are tax deductible Depreciation tax benefits to lessor/lessee Flexibility in structuring lease rental payments to lessee but costly source of finance

GLOBAL DEPOSITORY RECEIPTS (GDRs)



Means of raising funds from foreign investors in the form of shares issued in foreign countries Mechanism by which such foreign shares issued are held by a depository A depository is usually a large international bank which receives dividends , reports etc on behalf of the individual investors Each depository receipt (DR) represents a claim against a specified number of shares They are denominated in a convertible currency usually US $

GDRs (contd)
 

They are listed and traded on international stock exchanges The issuer pays dividends in home currency which is converted into dollars by the depository and distributed to DR holders Shown as share capital only on conversion (two way fungibility) Represent non voting shares firm enters into an agreement with depository If ADR, listed on NYSE/ NASDAQ , adherence to US GAAP , several levels (1 to 3)

FOREIGN BONDS


Means of raising foreign funds in the form of bonds issued in foreign countries Denominated in foreign currency known by local names like Yankee bonds, Samurai bonds Like domestic bonds they also have face value, coupon rate, maturity period , fixed or floating rates of interest ( LIBOR + basis points where 100 basis points = 1%)

FOREIGN LOANS
 

Foreign currency loans from banks Syndicated credits-Where two or more creditsbanks join together to lend large amounts, lead manager acts as agent and administers loan disbursing funds , collecting and distributing interest + principal repayments Foreign funds are classified as ECBs (External commercial borrowings) and include bank loans, suppliers credit, foreign bonds, loans from IFC,ADB etc and GDRs

TERM LOANS - features

   

Loans given by banks/financial institutions on long term basis Interest payments and principal repayment generally spread over 8 15 yrs Loans available for setting up new projects and also for expansion/renovation Allowed in both rupee loans and foreign currency loans for meeting cost of imported equipment , cost of technology , knowhow etc Loan account maintained in foreign currency, interest & instalments converted to rupees on repayment at prevailing rates

TERM LOANS (contd)



 

Security/Collateral by hypothecation / mortgage of property Generally by first charge on the assets financed and second charge on all other assets of the firm Restrictive covenants imposed Asset financing vs. project financing

Asset financing vs. project financing



In asset financing, loans given for assets like vehicles , equipment repayable in medium term of 3-5 yrs 3In project financing, loans granted for large scale investment projects on the expectation that it will realise a cash flow sufficient to cover cost of operations and debt service. Involves project appraisal of technical, economic and financial aspects for evaluating project feasibility both strengths and weaknesses are considered.

Significance of project appraisal



 

Since projects involve  Substantial cash outlays upfront  Benefits extend into the future  Irreversible decisions To stop bad projects from being accepted To prevent good projects from being rejected

Project appraisal


A detailed feasibility study is done and Detailed Project Report (DPR) is compiled giving  Project cost estimate  Means of financing  Schedule of implementation  Projected profitability projected sales , costs  Projected cash flow and debt servicing capability  Social profitability

Project appraisal
     

Market appraisal Technical appraisal Economic appraisal Ecological appraisal Managerial appraisal Financial appraisal

Market appraisal


     

Estimates of aggregate demand and market share data for the proposed product/service Consumption trends past and present Supply trends past and present Production possibilities & constraints Imports and exports Elasticity of demand Distribution channels , marketing policies

Technical appraisal


    

Seeks to determine whether the prerequisites for successful project commisioning have been considered and reasonably good choices have been made regarding location, size and process Availability of required quality & quantity of raw material and inputs Availability of utilities like power, water etc Appropriateness of plant design & layout Proposed technology vs. alternatives available Optimality of scale of operations Technical specifications of P&M etc

Economic appraisal
 

Involves social cost benefit analysis Economic benefits & costs measured in terms of shadow (efficiency) prices Impact of project on income distribution, level of savings and investments Contribution of project towards economic/ social objectives like self sufficiency, employment generation, social order etc

Ecological appraisal


Particularly for projects like power plants, irrigation, environment polluting industries like bulk drugs and chemicals in terms of


Likely damage to be caused to the environment Cost of restoration measures for ensuring that damage is minimised/within acceptable limits

Managerial appraisal
 

Capacity & commitment of core promoters and top management (based on past performance , other ventures, progress achieved on present venture etc) Capacity
     

Ability to plan clearly and set realistic goals & objectives Ability to organise Ability to select right kind of people and lead them effectively Negotiating capability Problem solving abilities Communication and HR skills Willingness to bring in more capital into project if needed Ability and willingness to work hard, take on new challenges and adaptability to different circumstances

Commitment
 

Financial appraisal


For evaluating profitability and financial strength of business To study financial viability in terms of debt servicing plus ability to satisfy capital providers on their expected rates of return
     

Project cost Means of financing and cost of capital Projected profitability Breakeven point Projected cash flows and financial position Level of risk

Financial appraisal
 

 

Includes identification of various elements of project cost Determination of accuracy of individual cost elements Accuracy of assumptions with reference to sales figures , growth rates and operating costs Suitability of proposed financing pattern Ability of project to generate adequate cash flows for debt servicing as well as for providing adequate rate of return to capital financiers

Financial appraisal


Cost benefit analysis must be done capital budgeting analysis Costs will be in terms of


Capital expenditure or initial outlay to be incurred generally at t0 Annual operating costs including materials, labour,overheads(both variable & fixed costs)

Benefits will be in terms of increase in revenues or cost savings or both over n number of years

Defining costs and benefits



Costs and benefits are measured in terms of cash flows (not on accrual based accounting profits) which means all non cash income/expenses are adjusted for:
 

Profit = (Revenues Expenses) (1-tax rate) (1Cash flows = EBIT (1-t) + Non-cash expenses like (1Nondepreciation / amortisations where EBIT = Earnings before interest & tax , and t = tax rate

Costs represent cash outflows; benefits represent cash inflows

Defining costs and benefits

   

Post tax cash flows to be considered Incremental cash flows must be considered Opportunity costs must be considered Net cash flows to be considered from perspective of suppliers of long term funds


Interest on long term loans not to be included as it is recognised as an opportunity cost in the discount rate and if taken into account will lead to double counting Interest on short term borrowings is however included

Determining project cost

       

Land & building Plant & machinery Technical knowhow, engineering & consulting fees Expenses on account of foreign technicians, training of Indian technicians abroad Misc. fixed assets like elec. installations, furniture & fittings Preliminary & pre operative expenses Provisions & contingencies Margin on working capital (Note: All except margin on working capital are capital costs)

Steps in capital budgeting



Step 1: Determine cash flows over the life of the 1: project ( incremental cash flows )
  

Initial cash flow (outflow) Annual cash flows (inflows) Terminal cash flows (inflows)

Step 2: Bring them down to present value to make cash flows over different time periods comparable.


Discounting technique

Step 3: Apply appropriate technique for evaluation 3:

Steps in capital budgeting

1) Determining Cash Flows
Look at all incremental cash flows occurring as a result of investment Initial cash outflow = Capital expenditure + initial investment in working capital (Total project cost except contingency) Annual Cash Flows over the life of the project = EBIT (1-t) + Depreciation +/(1+/Decrease/increase in working capital Terminal Cash Flows = Salvage value of assets + working capital released at the end

Step 1- Determining cash flows 1-

Initial cash outflow

Terminal Cash flow

...

Annual Cash Flows

Step 2: Discounting


Bring down all future cash flows to present value (discounting process) by using a discount rate reflecting time value and risk A rupee today is worth more than a rupee tomorrow A rupee received tomorrow will be worth something less today Present Value (PV) of Re.1 received after n years = 1 / (1+r )n where r = interest rate or discount rate
Eg. At a discount rate of 10% , PV of Re.1 received after 1 yr = 1/ 1.1 = Re.0.90, after 2 yrs = 1/ (1.1)2 = Re.0.83

Step 2: Discounting


The discount rate represents an opportunity cost or required rate of return ( k or r ) We can use the firm s cost of capital or cost of funds as the discount rate for investment projects. Cost of capital is a weighted average cost of all sources of financing
 

Cost of equity and retained earnings Cost of debt (post tax)

Illustration for discounting



A project gives cash flows as follows: Year 1 = Rs.4000, year 2 = Rs. 5000 and year 4 = Rs.8000 What is the worth of the investment today if the cost of capital is 8% ? Solution: PV = 4000 + 5000 + 8000 (1.08) (1.08)2 (1.08)4 = 3704 + 4274 + 5882 = 13860

Step 3: Evaluation techniques



The ideal evaluation method should:

a) include all cash flows that occur during the life of the project, money, b) consider the time value of money, c) incorporate the required rate of return on the project taking into account risk

Evaluation techniques
    

Accounting rate of return (ARR) Payback period (PB) Net Present Value ( NPV) Profitability Index ( PI) Internal Rate of return ( IRR)
(NPV, IRR and PI are called discounted cash flow techniques)

Evaluation techniques


ARR: ARR: Gives rate of return project is generating with reference to accounting profits and not cash flows it is an average return on investment (ROI) Payback It gives the number of years in which project will breakeven ie when the cash inflows will equal the cash outflows Net present value Gives the amount by which PV of cash inflows exceeds cash outflows Internal rate of return Gives the rate at which PV of cash inflows = cash outflows Profitability index Gives the ratio of cash inflows to cash outflows

Accounting rate of return

ARR = Average income or Profit after tax Average investment Eg. By investing in a machine costing Rs.90000 a company expects the following benefits over the next 3 years: PAT = Rs.20000, 22000 & 24000 Machine will be depreciated at Rs.10000 per annum, calculate ARR

Accounting rate of return

 

ARR = Ave. PAT / Ave. investment Average PAT = (20000+22000+24000) / 3 = 22000 Ave. investment =(90000+80000+70000)/ 3 = 80000 ARR = 22000 / 80000 = 27.5%

Payback Period


Time taken for the project to generate enough cash to pay for itself
0

(500) 150 150 150 150 (500) (300) 0

Payback period calculated by taking into account cumulative cash flows until year of full recovery of investment 3.33 years

Payback Period
 

Is a 3.33 year payback period acceptable? Firms that use this method will compare the payback calculation to some standard set by the firm. If management sets a cut-off of 4 years cutfor projects , what would be the decision? Accept the project. project.

Drawbacks of Payback Period

  

Firm cutoffs are subjective. subjective. Does not consider time value of money. money. Does not consider any required rate of return. return. Does not consider all of the project s cash flows. This project is clearly flows. unprofitable, but we would accept it based on a 4-year payback criterion! 4-

Discounted cash flow - DCF techniques



NPV, IRR and PI :

 

Examines all net cash flows Considers the time value of money (discounting process) Considers the required rate of return (cost of capital is used as discount rate).

Net Present Value

y NPV = PV of the annual net cash inflows (CF) - the initial outlay (IO) n

NPV =

7
t=1

CFt t (1 + k)

- IO

Net Present Value Decision Rule: Rule:

y y

If NPV is positive, accept. accept. If NPV is negative, reject. reject.

Illustration
 

Cash outflow at to = 1,00,000 Cash inflows ( Years 1-5) = 20000, 30000 1, 40000,50000,30000 Cost of capital = 12%

NPV calculation
 

NPV = PV of cash inflows - IO NPV = 20000/1.12 + 30000 / (1.12)2 + 40000 / (1.12) 3 + 50000 / (1.12)4 + 30000/ (1.12)5 - 100000 = 119060 - 100000 = 19060 As NPV is positive ACCEPT project

Profitability Index
n

NPV =

7
t=1 n

CFt t (1 + k)

- IO

PI =

7
t=1

CFt t (1 + k)

IO

Profitability Index yDecision Rule: yIf PI is greater than or equal to 1, accept. yIf PI is less than 1, reject. yCalculate PI for illustration yPI = 119060 /100000 =1.19 yAs PI > 1 , ACCEPT project

Internal Rate of Return (IRR)

IRR: IRR: IRR is simply the rate of return that the firm earns on its capital budgeting projects.  IRR is the rate of return that makes the PV of the cash inflows equal to the initial outlay ie where NPV = 0


Internal Rate of Return (IRR)

IRR:

7
t=1

CFt t (1 + IRR)

= IO

IRR
y

Decision Rule:If IRR is greater Rule: than or equal to the required rate reject. of return, accept else reject. In the illustration, IRR works out to 18% If required rate or cut off rate is 15% then ACCEPT project

Illustration 1
Given following cash flows: (900) 0
 

300 1

400 2

400 3

500 4

600 5

Find the payback period Using a discount rate of 15%, find NPV. NPV. Also calculate PI and IRR.

Illustration 1
 

Payback = 2 yrs NPV = PV of cash inflow IO = [ 300/1.15 + 400/(1.15)2 + 400/(1.15)3 + 500 / (1.15)4 + 600/(1.15)5 900 = 510 PI = PV of cash inflow / IO = 1410 / 900 = 1.57 IRR = 34%

Illustration
  

 

The cost of a new machine is Rs.1,77,000. Rs.1,77,000. Installation will cost Rs.20,000. Rs.20,000. Rs.4,000 in net working capital will be needed at the time of installation. The machine will increase revenues by Rs.85,000 Rs.85,000 per year, but operating costs will increase by 35% of the revenue increase. Straight line depreciation is used. Project life is 5 years

ILLUSTRATION(contd.)


  

Salvage value at the end of year 5 will be Rs.50,000. Rs.50,000. Discount rate is 14% 34% marginal tax rate. Calculate Payback , NPV, PI & IRR - should the project be accepted?

Step 1: Evaluate Cash Flows

a) Initial Outlay: What is the cash Outlay: outflow at time 0? Purchase price of the asset + shipping and installation costs = Depreciable asset value + Investment in working capital = Initial Outlay

Step 1: Evaluate Cash Flows

a) Initial Outlay: What is the cash Outlay: flow at time 0? 177,000 + 20,000 197,000 + 4,000 201,000 Purchase price of asset shipping and installation depreciable asset value net working capital initial outlay

Step 1: Evaluate Cash Flows

b) Annual Cash Flows: Flows: What incremental cash inflows occur over the life of the project? Determine operating cash flow as EBIT (1-t) +Depreciation (1Adjust for changes in working capital

Incremental revenue - Incremental costs * - Depreciation = Incremental earnings before taxes - Tax = Incremental earnings after taxes + Depreciation = Operating Cash Flow - / + Increase/decrease in working capital = Annual cash flow (NCF)

For Years 1 -5
85,000 (29,750) (29,400) 25,850 (8,789) 17,061 29,400 46,461 = Revenue Costs Depreciation* EBT Taxes EAT Depreciation Annual Cash Flow salvage)/ No. of yrs

*Depn =(Asset value

Step 1: Evaluate Cash Flows

Flow: c) Terminal Cash Flow: What is the cash flow at the end of the project s life? Salvage value + Recapture of net working capital = Terminal Cash Flow

Step 1: Evaluate Cash Flows

Flow: c) Terminal Cash Flow: What is the cash flow at the end of the project s life? 50,000 4,000 54,000 Salvage value Recapture of NWC Terminal Cash Flow

Payback period
IO = 201,000  CF(1 - 4) = 46,461*4 = 1,85,844  Balance to be recovered = 15,156  Recovered in 15,156 / 46461 = .33 yrs  Payback period is 4.33 yrs.


Project NPV:
IO = 201,000  CF(1 - 4) = 46,461 per annum  CF(5) = 46,461 + 54,000 = 1,00,461  Discount rate = 14%  Discount factors = 1/ (1 + k)t = 1/ 1.14 , 1/ (1.14)2 , 1/ (1.14)3 etc  NPV = 1,87,544 2,01,000 =(-) =(13,456


PI & IRR
PI = 187544 / 201000 = . 93 (REJECT)  IRR = 11-12 % (ACCEPT if IRR > 11required rate )


Which method to use?



Payback gives no. of years taken to recover investment popular as a rough and ready measure as it is easy to compute and understand NPV gives absolute value in Rupees positive NPV adds to shareholder wealth so conceptually a sound measure IRR gives rate of return in % terms - assumes reinvestment of funds at same rate (Modified IRR overcomes this problem), can be used when cost of capital is unknown PI is an index used in times of capital rationing to rank projects in order of highest cash inflows for every rupee of cash outflow

DCF calculation
YEARS Revenue / Cost savings Less: Operating expenses Less: Depreciation EBIT Less: Tax EBIAT Add: depreciation Operating cash flows 1 2 3 4 5

DCF calculation (contd)

YEARS Operating cash flow Less: CAPEX Less: Working Capital changes Add: terminal value Annual Cash Flow (ACF) Present value @ discount rate NPV = PV ( ACF ) - IO 1 2 3 4 5

Problem 1 (New project)

 

  

Bell ltd. is considering launching a new type of electronic bell Expected sales are 2000 units in year 1 with growth @10% each year Selling price of Rs.250 each Project life = 4 years Unit variable cost = Rs.120 per unit and incremental fixed costs = Rs.1,05,000 p.a New equipment costs Rs.2,80,000 which can be sold after 4 years for Rs.30,000

Problem 1(contd.)
 

 

Depreciation @ 20% on WDV basis Adspend on promoting the new product would be Rs.18,000 upfront Initial working capital will be @ 5% of first year sales and will be fully liquidated in 4th year at book value. The tax rate is 40% Calculate payback , PI and NPV of the project at 16% discount rate

Op.CF Revenues Less:VC Less:FC Less:Depn PBT Less:Tax PAT OCF(PAT+De pn.)

Year 1 500000 240000 105000 56000 99000 39600 59400 115400

Year 2 550000 264000 105000 44800 136200 54480 81720 126520

Year 3 605000 290400 105000 35840 173760 69504 104256 140096

Year 4 665500 319440 105000 28672 212388 84955 127433 156105

Op.CF OCF (c/f) Less: Increase in W.Cap* Add: Terminal Value ACF PVIF PV

Year 1 115400 -

Year 2 126520 -

Year 3 140096 -

Year 4 156105 -

55000 115400 .862 99475 126520 .743 94003 140096 .641 89802 211105 .552 116530

2Schange assumed

Solution 1


Initial outlay = Cost of machine + Initial WC + Initial advertisement = 280000 +25000 +18000 = 323000 Terminal cash flow = Salvage value + WC released = 30000 + 25000 = 55000 NPV = PV ( Cash inflows) Initial outlay = 399810 - 323000 = + 76810 ( ACCEPT)

Cash flows in replacement decisions



Initial outlay = Cost of new asset salvage value of old asset if sold today Annual cash flows = (Increased revenues or cost savings from replacement less incremental depreciation) (1 t) + incremental depreciation Terminal cash flows = Salvage value of new asset at end of useful life less salvage value of old asset lost (opportunity cost)

Problem 2 (Replacement)
 

  

Bell ltd. wants to buy a new machine Old machine is being depreciated at Rs.5000 p.a and can be sold for Rs.15000 today ; if sold after 5 years then Rs.2000 salvage New machine costs Rs.2,50,000 and will be depreciated on straight line basis over 5 years , salvage value after 5 yrs would be Rs.50,000 Cost savings would be Rs.50,000 p.a Tax rate = 40%, cost of capital = 15% What is the NPV?

Solution 2


 

IO = Cost of new machine salvage value of old machine =250000 15000 = 2,35,000 Terminal value = 50,000 2000 = 48,000 Benefits =Cost savings Incremental depn. = 50000 (40000-5000) = 15000 (40000ACF = 15000(1-.4) + 35000 (depn)= 15000(144000 NPV = PV (CI) IO
= 171344 235000 = (63656) REJECT

Annual capital charge



Transforms a lumpsum of investment today into an equivalent stream of future cash flows (annuity) Used in calculating capital recovery (EMI/EAI) and evaluating project proposals Where projects are mutually exclusive, have different cash flow patterns and unequal lives eg. choosing between fork lift and conveyor belt for transportation of materials/goods

Annual capital charge



Step 1: Determine the initial outlay (IO) and present value of operating costs using cost of capital (k) as the discount rate Step 2: Divide the present value obtained in step 1 by present value annuity factor (PVAF) for n yrs at k rate

Annual capital charge = IO + PV (Op. costs) PVAF (n yrs , k%)

Annual capital charge (ACC)



Eg. Initial outlay= 400 crs, Cost of capital = 7%, n = 25 yrs; how much revenue is required to be earned each year to recover investment or repay loan in equated annual instalments? Annual revenue or ACC = 400 / PVAF( 25 yrs, 7%) = 400 / 11.65 = 34.3 crs

Illustration


Machine A:
Initial cost = Rs.15 lakhs  n = 3 yrs  Operating cost p.a = Rs.5 lakhs


Machine B:
Initial cost = Rs.10 lakhs  n = 2 yrs  Operating cost p.a = Rs.6 lakhs


 

Which machine should be bought? Discount rate = 6%

Calculating PV of costs
C0 C1 C2 C3 PV@6% A= 15 5 5 5 28.37 B= 10 6 6 21.00 Should B be bought? Not necessarily as it would mean replacement a year earlier than A So calculate annual capital charge

   

Calculating ACC


Machine A:
  

PV of A s costs = 28.37 PVAF (3 yrs, 6%) = 2.673 ACC = 28.37/ 2.673 = 10.61 PV of B s costs = 21 PVAF (2 yrs, 6%) = 2.723 ACC = 21 / 2.723 = 11.45

Machine B:
  

A to be bought as ACC(A) < ACC (B)