Question

The manager of a canned food processing plant is trying to decide between two labelling machines. a) Construct the incremental net cash flow table for each year. b) Determine the number of positive roots for the incremental cash flow. c) Determine the rate of return for the incremental cash flow based on PW analysis. d) Determine which machine should be selected. Use MARR of 20% per year. Please enter your final answers below in addition to uploading your detailed answer to your professor MS Teams after the exam. (25 Points) First Cost $ Annual Operating Cost $ per year Salvage Value $ Machine 1 Machine 2 -15,000 -25,000 -1,600 -400 3,000 4,000 2 4 Life, years

Answer 1

FIRST START WITH BASIC

What is Incremental Cash Flow?

• Incremental cash flow is the additional operating cash flow that an organization receives from taking on a new project. A positive incremental cash flow means that the company's cash flow will increase with the acceptance of the project. A positive incremental cash flow is a good indication that an organization should invest in a project.

KEY TAKEAWAYS

• Incremental cash flow is the potential increase or decrease in a company's cash flow related to the acceptance of a new project or investment in a new asset.
• Positive incremental cash flow is a good sign that the investment is more profitable to the company than the expenses it will incur.
• Incremental cash flow can be a good tool to assess whether to invest in a new project or asset, but it should not be the only resource for assessing the new venture.

Understanding Incremental Cash Flow

• There are several components that must be identified when looking at incremental cash flows: the initial outlay, cash flows from taking on the project, terminal cost or value, and the scale and timing of the project. Incremental cash flow is the net cash flow from all cash inflows and outflows over a specific time and between two or more business choices.

For example,

• a business may project the net effects on the cash flow statement of investing in a new business line or expanding an existing business line. The project with the highest incremental cash flow may be chosen as the better investment option. Incremental cash flow projections are required for calculating a project's net present value (NPV), internal rate of return (IRR), and payback period. Projecting incremental cash flows may also be helpful in the decision of whether to invest in certain assets that will appear on the balance sheet.

Example of Incremental Cash Flow

• As a simple example, assume that a business is looking to develop a new product line and has two alternatives, Line A and Line B. Over the next year, Line A is projected to have revenues of $200,000 and expenses of $50,000. Line B is expected to have revenues of $325,000 and expenses of $190,000. Line A would require an initial cash outlay of $35,000, and Line B would require an initial cash outlay of $25,000.

To calculate each project's net incremental cash flow for the first year, an analyst would use the following formula:

\begin{aligned} &\text{ICF}=\text{ Revenues }-\text{ Expenses }-\text{ Initial Cost}\\ &\textbf{where:}\\ &\text{ICF}=\text{Incremental cash flow} \end{aligned}​ICF= Revenues − Expenses − Initial Costwhere:ICF=Incremental cash flow​

In this example, the incremental cash flows for each project would be:

\begin{aligned} &\text{LA ICF}= \$200,000 - \$50,000 - \$35,000 = \$115,000\\ &\text{LB ICF}= \$325,000 - \$190,000 - \$25,000 = \$110,000\\ &\textbf{where:}\\ &\text{LA} =\text{ Line A incremental cash flow}\\ &\text{LB} =\text{ Line B incremental cash flow} \end{aligned}​LA ICF=$200,000−$50,000−$35,000=$115,000LB ICF=$325,000−$190,000−$25,000=$110,000where:LA= Line A incremental cash flowLB= Line B incremental cash flow​

Even though Line B generates more revenue than Line A, its resulting incremental cash flow is $5,000 less than Line A's due to its larger expenses and initial investment. If only using incremental cash flows as the determinant for choosing a project, Line A is the better option.

THIS EXAMPLE IS FOR CLEAR ALL CONCEPTS

A.

cashflow is the net cash flow from all cash inflows and outflows over a specific time and between two or more business choices.

Machine 1

15000-3000/2 = 6000+ 1600 = 7600

Machine 2.

25000-4000/4 = 5250+400= 5650

Comparison between 1 & 2 machines . Machine 1 is more economical than machines 2

B.

business may project the net effects on the cash flow statement of investing in a new business line or expanding an existing business line. The project with the highest incremental cash flow may be chosen as the better investment option. Incremental cash flow projections are required for calculating a project's net present value (NPV), internal rate of return (IRR), and payback period. Projecting incremental cash flows may also be helpful in the decision of whether to invest in certain assets that will appear on the balance sheet.

assume that a business is looking to develop a new product line and has two alternatives, Line A and Line B. Over the next year, Line A is projected to have revenues of $200,000 and expenses of $50,000. Line B is expected to have revenues of $325,000 and expenses of $190,000. Line A would require an initial cash outlay of $35,000, and Line B would require an initial cash outlay of $25,000.

Incremental cash flows are determined by subtracting firm cash flows without the project from firm cash flows with the project. If lower sales of existing products are a direct result of introducing the new products, the company should deduct the lost cash flows from expected cash flows from the new products.

C.

When comparing two or more alternatives, the alternative with the highest ROR is not necessarily the alternative that maximizes profit at the MARR, which is the appropriate goal. For example, suppose that an investor with at least $1,000 available to invest is considering two mutually exclusive investment alternatives, X and Y, as follows:

Alternative X (ROR = 100%)

EOY NCF ($)

0 - 10

1 + 20

Alternative Y (ROR = 75%)

EOY NCF ($)

0 - 1000

1 + 1750

Despite having a lower ROR than alternative X, alternative Y is obviously the superior investment at any reasonable MARR because it generates more profit than X. Alternatives cannot be evaluated solely by comparing their individual ROR values. Comparisons must be made incrementally.

Example 1. Suppose that alternatives X and Y above are being considered by an investor with a MARR of 20%. The do-nothing alternative is rejected because the ROR of both X and Y is greater than 20%.

Next we set the default choice equal to X because it requires less investment than Y. If the incremental investment in Y over X is desirable, then we switch our selection from X to Y.

To determine if the incremental investment in Y over X is desirable, calculate the rate of return of the incremental net cash flow (Y - X). If the incremental ROR is greater than or equal to the MARR, then the more costly alternative (Y in this case) should be selected. Otherwise choose the lower cost alternative.

Form the incremental NCF by (more costly - less costly).

In this example, we form the incremental net cash flow (Y - X):

EOY 0: -1000 - (-10) = - 990

EOY 1: +1750 - (+ 20) = + 1730

EOY Incremental NCF ($)

0 - 990

1 + 1730

The rate of return of the incremental NCF is easily calculated in this example because the project duration is only one year:

Incremental ROR = ( 1,730 - 990) / 990 = 0.747 = 74.7%

Because the incremental ROR = 74.7% > MARR = 20%, the incremental investment in Y over X is desirable.

As was obvious from the data, the investor should select Y, the alternative with the lower ROR.

When three or more alternatives are under consideration, incremental ROR analysis is performed by a series of pairwise comparisons. At each step the current selection is compared to the least costly of the remaining alternatives under consideration. If the incremental ROR is greater than or equal to the MARR, then the more costly alternative is selected. Continue until all alternatives have been considered.

D.

A minimum acceptable rate of return (MARR) is the minimum profit an investor expects to make from an investment, taking into account the risks of the investment and the opportunity cost of undertaking it instead of other investments.

Machine 1 = 7600*100/15000*2years = 25.34%

Machine 2 = 5650*100/25000*4year= 5.65%

In this cenario clear machine 2 is most beneficial compre with machine 1

THANKS FOR REVIEW ME