Question

Mann Co is a listed company. In past several months, the stock price of the Mann Co has continued to decline due to operating losses, which makes the board of directors in face of great pressure. Mann Co' board is considering to invest in a new project to improve company's financial performance. According to the prediction of the Mann Co's financial manager, the new project life is expected to be 5 years. At the beginning of the project, the sales volumes and selling price of the products are relatively high. In the later stage of the project, with the entry of competitors, both the sales volume and unit price will decrease. The forecast sales volumes.śelling pnice, variable costs of the projects are as follows

Year    1    2 3 4    5

Sales (units/year) 110000    120000 120000 100000    80000

Selling price (S/unit) 300 300 300 270    250

Variable cost ($/unit)    170    170    170 170 170

The equipment needed to begin production has an installed cost of $30 m and the tax law allows Mann Co equipment depreciate to zero over 10 year using straight-line depreciation. Mann Co's financial manager forecast that this equipment can be sold for S2 m after completion ofthe project. In addition, production of the project will require $1.5m in net working capital to start and additional new working capital investments each year equal to 10% of the projected sales increase for the following years. The financial manager estingys that the annual factory building rental and other fixed expenditures are about $2m for each year. The marginal tax rate of Mann Co is 35% and the require return on the project is 12%

Required:(a). Cal culate the after-tax salvage value ofthe equipment. (5 marks)(b). Calculate the cash flow from asset for each year. (6 marks)(c). Calculate the Net Present Value of the project. (4 marks)(d). Calculate the Payback period of the project. (2 marks)(e), Would you suggest Mann Co invest this project? Why? (3 marks)

Answer 1

1. Calculation of after tax salvage value of the equipment As companies allowed to depriciate over zero value so we will not deduct salvage value for SLM method Cost of equipment = $30M Annual Depriciation = 30/10 $ 3 Ml each year Discounting Factor 1 0.892857 So the value at year end is Cost - Total Depriciation 2 0.797194 $30 M - (3M* 10Year) = 0 3 0.71178 at year end we are selling at $2m so my profit would be 2 m because value of asset is zero 4 0.635518 After tax salvage value of equipment is as followes 5 0.567427 Book Value 0 Less Selling value 2 ml Profit 2 ml Tax @ 35% 0.7 ml After tax salvage value of equipment 1.93 ml Present value of After tax salvage value 1.93*.567 1.09431 ml

1 2 3 4 5 110000 300 120000 300 100000 270 80000 250 27000000 17000000 2. Cash flow from Asset each year Particular Sale unit Sale price Total Sale price Sale unit* sale price less variable cost @ 170 Contribution Less fixed cost Profit before tax and drpriciation Less Depriciation Proft before tax Tax @35% Proft after tax Add Depriciation Cash flow after tax Salavage value Total Cash flow after tax 33000000 18700000 14300000 2000000 12300000 120000 300 36000000 20400000 15600000 2000000 13600000 3000000 10600000 3710000 6890000 36000000 20400000 15600000 2000000 13600000 3000000 10600000 20000000 13600000 6400000 2000000 4400000 3000000 3000000 9300000 10000000 2000000 8000000 3000000 5000000 1750000 3250000 3000000 6250000 3710000 6890000 3255000 6045000 3000000 9045000 3000000 3000000 9890000 1400000 490000 910000 3000000 3910000 1930000 5840000 9890000 9045000 9890000 9890000 6250000

3. Calculation of NPV Note Calculation of present value of cash outflow Year 0 0 1 Particular Equipment cost Net working capital 10% of projected sale 10% of projected sale 10% of projected sale 10% of projected sale 10% of projected sale Present value of cash outflow Discounting Present Amount factor @ 12% value 30000000 1 30000000 1500000 1 1500000 3300000 0.892857143 2946428.57 3600000 0.797193878 2869897.96 36000001 0.711780248 2562408.89 2700000 0.635518078 1715898.81 2000000 0.567426856 1134853.71 42729487.9 2 3 4 5 Note Prsent value of cash inflow Year 1 2 3 Cash inflow Df @ 12% Present value 9045000] 0.89285714) 8075892.857 9890000 0.79719388 7884247.449 9890000 0.71178025 7039506.651 62500001 0.63551808 3971987.99 58400001 0.56742686) 3313772.837 30285407.78 4 5 Present value of cash inflow Calculation of NPV Present value of cash inflow Less present value of cash outflow NPV 30285407.78 42729487.95 -12444080.2

Calculation of NPV Present value of cash inflow Less present value of cash outflow NPV 30285407.78 42729487.95 -12444080.2 4. calculation of payback period As npv is negative so investment will not be recovered in this 5 year 5, NOI don't suggets to invest in this project as we have negative NPV which mean we will face loss so it advisable to stay away from project
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