Question

The company is planning to acquire new equipment for a cost of $38000. Management has already conducted and paid $15000 for a marketing survey while delivery and installation costs are expected to be $9000 and $7400 respectively. Financing costs are $3000 per year. The economic life of the investment in 5 years and the new equipment will depreciate straight-line to a zero value over 5 years. The management learn expects this new equipment at the end of 5 years at a price of $4000

It expects the acquisition to increase sales by $6000 annually while cash operation costs are expected to increase by $3200 annually . This investment will allow the replacement of old equipment which can be sold for $5000. It had a book value of $10000 four years ago, but it has now fully depreciated. The marginal tax rate is 25% and the expected rate of return is 12%

Additional net working capital of $8000 will be needed immediately. When the project is terminated in 5 years, there no longer will be a need for this incremental working capital

(a)Compute the net investment

(b)Compute the net cash flow for each of the five years of the project (year 1-5)

(c)What is the NPV of the project

Answer 1

a) Statement showing net investment

Particulars	Amount
Cost of new equipment	38000
Add: Delivery cost	9000
Add: Installation cost	7400
Add: Wc required	8000
Less: Cash flow from the sale of old equipment = 5000 (1-tax rate) = 5000(1-25%) = 5000(0.75) = 3750	3750
Net investment	58650

Thus net investment = $58650

b) Statement showing OFC

Year	1	2	3	4	5
Increase in sales	6000	6000	6000	6000	6000
Less: Expense	3200	3200	3200	3200	3200
Less: Depreciation	10880	10880	10880	10880	10880
PBT	-8080	-8080	-8080	-8080	-8080
Tax @ 25%	-2020	-2020	-2020	-2020	-2020
PAT	-6060	-6060	-6060	-6060	-6060
Add: Depreciation	10880	10880	10880	10880	10880
OCF	4820	4820	4820	4820	4820

Statement showing total cash flow

Year	1	2	3	4	5	Total
OCF	4820	4820	4820	4820	4820
Terminal cash flow					11000
Total cash flow	4820	4820	4820	4820	15820

Note:

Cash flow from the sale of old equipment

Particulars	Amount
The selling price of equipment at end of year 5	4000
Book value of equipment	0
Profit	4000
Tax @ 25%	1000
Cash flow from the sale of equipment (4000-1000)	3000

Statement showing Terminal cash flow

Particulars	Amount
Cash flow from the sale of machine	3000
Release of WC	8000
Terminal cash flow	11000

c) Statement showing NPV

Year	1	2	3	4	5	Total
OCF	4820	4820	4820	4820	4820
Terminal cash flow					11000
Total cash flow	4820	4820	4820	4820	15820
PVIF @ 12%	0.8929	0.7972	0.7118	0.6355	0.5674
PV	4303.57	3842.47	3430.78	3063.20	8976.69	23616.72
Less: Initial Investment						58650.00
NPV						-35033.28

Thus NPV = -35033.28 $