Question

Cannelloni Berhad intends to purchase an equipment worth RM500,000. The new equipment will have a 5-year useful life and will be depreciated to zero using the straight-line method. An import duty of RM50,000 must be paid as the equipment is imported from Korea, on top of RM15,000 for shipping and RM5,000 for installation. The new equipment requires inventories of raw material to increase by RM20,000. Accounts payable is also expected to increase by RM8,000. The net operating working capital is expected to be recaptured at the end of the project. The equipment is expected to generate new sales of RM120,000 per year and is expected to save RM25,000 in labor and electrical expenses over the next 5-years. At the end of its useful life, the equipment is expected to have a disposal value of RM80,000. Cannelloni's marginal tax rate is 28 percent and has a required rate of return of 8 percent. Required: a) Calculate the initial cash outflow to purchase the new equipment. (2 Marks) b) Calculate the project's net present value and comment on the acceptability of the project. (8 Marks)

pls show calculation

Answer 1

a. Cost of the equipment = RM 500,000

Import duty charges = RM 50,000

Shipping Cost = RM 15,000

Installation Cost = RM 5,000

We know the Net Working Capital(NWC) = Change in Current Assets - Change in Current Liabilities

Here Change in Current Assets = increase in inventory = RM 20,000$

Change in Current Liabilities = Increase in Accounts Payable = RM 8,000

So NWC = 20,000 - 8,000 = RM 12,000

So, initial Cashflow to purchase the new equipment = (500,000 + 50,000 + 15,000 + 5,000) - (12,000) = RM 570,000

b.

Year 1:

Sales = RM 120,000

Savings = RM 25,000

Depreciation Expense = 500,000 / 5 = RM 100,000

Operating CF Before tax = 120,000 + 25,000 - 100,000 = RM 45,000

Tax @28% = RM 12,600

Net operating income after tax = 45000 - 12600 = RM 32,400

Net operating cash flow in year 1 = CF1 = 32,400 + 100,000 = RM 132,400 (Depreciation added back since it is a non cash expense)

Same will happen for the next 4 years.

So, CF2 = RM 132,400

CF3 = RM 132,400

CF4 = RM 132,400

For year 5, we need to calculate the terminal value also along with the operating cashflows.

So Book value of the equipment after year 5 = 0

Salvage Value = RM 80,000

Tax on capital gain = 80,000 * 0.28 = RM 22,400

NWC to be recaptured = - RM 12,000 (Negative because initially, it was an increase)

So, terminal Cash Flow = 80,000 - 22,400 - 12,000 = RM 45,600

So CF5 = RM 132,400 + 45,600 = RM 178,000

Discount rate = 8%

So, NPV = -570,000 + (132,400 / 1.08) + (132,400 / 1.08²) + (132,400 / 1.08³) + (132,400 / 1.08⁴) + (178,000 / 1.08⁵)

So, NPV = - RM 10,330.58

Since, the NPV is negative, the project should not be accepted.