Question

35. For a new process, the land was purchased for S10 million. The fixed capital investment, paid at the end of year 0, is $165 million. The working capital is S15 million, and the salvage value is $15 million. The estimated revenue from years 1 through 10 is $70 million/y, and the estimated cost of manufacture over the same time period is $25 million/y. The internal hurdle rate (interest rate) is 14% p.a., before taxes, and the taxation rate is 40%. a. Draw a discrete, nondiscounted cash flow diagram for this process. b. Determine the yearly depreciation schedule using the five-year MACRS method. c. Determine the after-tax profit for each year d. Determine the after-tax cash flow for each year e. Draw a discrete, discounted (to year 0) cash flow diagram for this process f Draw a cumulative, discounted (to year 0) cash flow diagram for this process. g. What is the present value (year 0) of this process?

Answer 1

(a)

Cash outflow in year 0 ($ million) = Cost of land + Fixed capital investment + Working capital = 10 + 165 + 15 = 190

Cash inflow in year 10 ($ million) = Revenue + Salvage value = 70 + 15 = 85

Cash flow diagram is as follows (Values in $ million).

(b)

MACRS depreciation schedule as follows.

Year	Asset Cost ($ MIllion)	Depreciation Rate (%)	Annual Depreciation ($ Million)
	(A)	(B)	(C) = (A) x (B)
1	165	20	33
2	165	32	52.8
3	165	19.2	31.68
4	165	11.52	19.008
5	165	11.52	19.008
6	165	5.76	9.504

(c)

Working notes:

(i) Pre-tax profit = Revenue - Manufacturing cost - Annual depreciation

(ii) After-tax profit = Pre-tax profit x (1 - Tax rate) = Pre-tax profit x (1 - 0.4) = Pre-tax profit x 0.6

Year	Revenue ($M)	Cost ($M)	Depreciation ($M)	Pre-tax Profit ($M)	After-tax Profit ($M)
	(D)	(E)		(F) = (D) - (E) - (C)	(G) = (F) x 0.6
0		190			-190
1	70	25	33	12	7.2
2	70	25	52.8	-7.8	-4.68
3	70	25	31.68	13.32	7.992
4	70	25	19.008	25.992	15.5952
5	70	25	19.008	25.992	15.5952
6	70	25	9.504	35.496	21.2976
7	70	25	0	45	27
8	70	25	0	45	27
9	70	25	0	45	27
10	85	25	0	60	36

(d)

After-tax cash flow = After-tax profit + Annual depreciation

Year	After-tax Profit ($M)	Depreciation ($M)	After-tax Cash Flow ($M)
	(G)	(C)	(H) = (G) + (C)
0	-190		-190
1	7.2	33	40.2
2	-4.68	52.8	48.12
3	7.992	31.68	39.672
4	15.5952	19.008	34.6032
5	15.5952	19.008	34.6032
6	21.2976	9.504	30.8016
7	27	0	27
8	27	0	27
9	27	0	27
10	36	0	36

NOTE: As per Answering Policy, 1st 4 parts are answered.