Question

Spacely Sprockets is considering increasing its production of sprockets at its Orbit City plant. You have been provided the following pieces of information on this ten year project.

• The expansion will require the purchase of machinery costing $50,000,000.
• The firm has spent $750,000 to train workers to use the new machinery. If the project is accepted, the firm expects to spend an additional $350,000 in training costs payable today (t=0).
• The sales from this project will be $20,000,000 per year. The operating expenses (excluding depreciation) equal $11,000,000.
• The company uses straight-line depreciation. The project has an economic life of 10 years and the machinery has a salvage value of $8,000,000.
• Because of the project, the company will need additional net working capital of $300,000, which can be liquidated at the end of ten years.
• Spacely’s marginal tax rate is 40%.
• Spacely’s cost of capital (WACC) is 10%.

1. The project’s cash flow in year 9 is $ ________.
2. The project’s cash flow in year 10 is $ ________.

Answer 1

1. The project’s cash flow in year 9 is $ 3,138,322.

2. The project’s cash flow in year 10 is $ 4,819,291.

Year	0	1	2	3	4	5	6	7	8	9	10
Purchase of Machine	-50000000
Training expense	-1100000
Working capital	-300000
Sales		20000000	20000000	20000000	20000000	20000000	20000000	20000000	20000000	20000000	20000000
Less: Operating cost		-11000000	-11000000	-11000000	-11000000	-11000000	-11000000	-11000000	-11000000	-11000000	-11000000
Less- Depreciation		-5000000	-5000000	-5000000	-5000000	-5000000	-5000000	-5000000	-5000000	-5000000	-5000000
Net Profit		4000000	4000000	4000000	4000000	4000000	4000000	4000000	4000000	4000000	4000000
Less: Tax @ 10%		1600000	1600000	1600000	1600000	1600000	1600000	1600000	1600000	1600000	1600000
Profit After tax		2400000	2400000	2400000	2400000	2400000	2400000	2400000	2400000	2400000	2400000
Add- Depreciation		5000000	5000000	5000000	5000000	5000000	5000000	5000000	5000000	5000000	5000000
Net cash Flow		7400000	7400000	7400000	7400000	7400000	7400000	7400000	7400000	7400000	7400000
Release of Working capital											300000
Cashflow on salvage value*											4800000
Net cash flow at end										7400000	12500000
PVF @10%	1	0.9090909	0.8264463	0.7513148	0.6830135	0.6209213	0.5644739	0.5131581	0.4665074	0.4240976	0.3855433
Present value of cash flow	-51400000	6727272.7	6115702.5	5559729.5	5054299.6	4594817.8	4177107.1	3797370.1	3452154.6	3138322.4	4819291.1

Salvage value	8000000
Book Value	0
Net profit	8000000
Less: tax @40%	3200000
Net cashflow on Salvage value	4800000