Question

10. Company Z is considering adding a new piece of equipment which will produce a new product. The machine would be set up in unused space in Ace's plant. The will cost $288,000. It would cost $33,000 for shipping. $20,000 for a contract base for the machine, $12,000 for contractors to install the machine. Additionally, electric is installed at a cost of 24,000 and another $5,000 for electric for an adjacent machine which is not used to process the new product. The Company also spent $5,550 to clean their entire warehouse. The depreciation on the machine is for 4 years utilizing the straight line method. The Company's effective tax rate is 40%. The output for the machineris 55,000 units a year. Each unit is expected to sell at a price of $12 each with a pitee increase for inflation of 2% each year subsequent to year You have also been able to uncover the following costs: Direct materials per unit: $1.50 Direct labor per unit: $2.50 Utility costs per unit: $3 The Company's WACC is 4%. Part 1: What is the NPV of this machine purchase? Would you purchase the machine? What is the IRR, MIRR and Payback period? Part 2: Instead of buying the new machine, the Company could obtain $80,000 per annum for the space in which the machine will be placed. Does this change your answer in part 12

Answer 1

Please find the answer in given screen shots,

Amount in $.

Part 1 Calculation of NPV for the Machine Year 1 Year 2 Year 3 Year 4 NPV Year 0 -353,000.00 -24,000.00 -5,000.00 Total Cost of Capital Installation of Electic Warehouse Cleaning Cash from Operations Net Cash Flow Discount Factor @ 4% Discounted Cash Flow -382,000.00 1.00 -382,000.00 200,300.00 200,300.00 0.9615 192,596.15 208,220.00 208,220.00 0.9246 192,511.09 216,298.40 216,298.40 0.8890 192,288.49 224,538.37 224,538.37 0.8548 191,936.34 387,332.08 NPV 387,332.08 Proving with excel formula = npv(rate,cf1,cf2,cf3,cf4)-cfo) $387,332.08 Since the NPV is Positive - Yes we would purchase the Machine. Calculation of IRR Using Excel Formula of IRR(values) or by Financial Calculation = 40.78% Alternatively we can arrive NPV using one more discount factor and by extrapolating the NPVs and Discount rates of both the cases. R1 NPV 1 R2 NPV 2 40% 4,581.25 50% -47,482.77

IRR = R1 + NPV1 X (R2-R1)/(NPV1 - NPV2) R2-R1 NPV1 - NPV2 NPV1 X (R2-R1) NPV1 X (R2-R1) / (NPV1 - NPV2) IRR (putting the numbers in Formula) 10% $52,064 $458 0.008799262 40.88% Calculation of Payback Period Year Cash flow Net Invested Cash -382,000.00 200,300.00 -181,700.00 208,220.00 26,520.00 216,298.40 242,818.40 224,538.37 467,356.77 We see that till Year 1 we have not recovered all the invested amount but at Year 2 we have receoved as well as we have some more. To get the exact month we can arrive as below, Cash Inflow of Year 2 208,220.00 Per Month flow 17,351.67 Required recovery 181,700.00 Hence Recovery months = Required Recovery / Per month flow 10.47 Therefore Payback period is 1 Year and 10.47 months

Cash flows from Operation Year 1 55,000.00 12.00 Output Sales Price - incl of Inflation Direct Material per UNIT Direct Labour per UNIT Utility Cost per UNIT Year 2 55,000.00 12.24 1.50 2.50 3.00 Year 3 55,000.00 12.48 1.500 2.50 3.00 Year 4 55,000.00 12.73 1.50 1.50 2.50 3.00 2.50 3.00 Revenue Less: Direct Material Less: Direct Labour Less: Utility Cost EBITDA Less: Depreciation EBIT Less: Tax @ 40% EAT Add: Depreciation Cash from Operations 660,000.00 82,500.00 137,500.00 165,000.00 275,000.00 88,250.00 186,750.00 74,700.00 112,050.00 88,250.00 200,300.00 686,664.00 82,500.00 137,500.00 165,000.00 301,664.00 88,250.00 82,500.00 137,500.00 165,000.00 288,200.00 88,250.000 199,950.00 79,980.00 119,970.00 88,250.00 208,220.00 700,397.28 82,500.00 137,500.00 165,000.00 315,397.28 88,250.00 227,147.28 90,858.91 85,365.60 128,048.40 88,250.00 216,298.40 136,288.37 88,250.00 224,538.37

WN Machine Cost Shipping Contract Base Installation Total Cost of Machine Life of Machine Deprecation/Year 288,000.00 33,000.00 20,000.00 12,000.00 353,000.00 4 Years 88,250.00 Part 2 NPV of Space Rental Year NPV Revenue from Space Discount Factor @ 4% Discounted Cash Flow 0.00 1. 00 0.00 Year 1 80000 0 .9615 76,923.08 Year 2 80000 0.9246 73,964.50 Year 3 80000 0.8890 71,119.71 Year 4 80000 0.8548 68,384.34 290,391.62 NPV 290,391.62 4% Proving with excel formula = npvrate,cf1,cf2,cf3,cf4)-cfo) $290,391.62 The NPV is lessor than what we might get on buying maching and doing the business hence the recommendation will be towards buying the Machine. As per Part 1 Answer - Machine should be purchased - Part 2 answer doesn't change the decision which is taken in part 1

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