Question

You work in the finance department of Fresh Dumplings Pty Ltd. The company is considering the prospect of purchasing cooking equipment and your manager has asked you to do financial analysis to help inform the company’s decision. The equipment costs $180,000 installed and, according to the Australian Taxation Commissioner schedule, will have an effective life of 9 years.
Your manager has asked you to use the straight-line depreciation method (i.e. allocate cost evenly over the useful life) for tax purposes and management expects it will be able to sell the oven at the end of its effective life for $30,000.
Your manager has given you the following data to use in your analysis. It is estimated that the additional oven will increase annual sales by $160,000 and operating expenses will be 80% of revenues. The expansion is also expected to increase sales of other food and drink within the business by $40,000 with associated costs averaging 50% of sales. An additional investment of $15,000 inventory will also be required. The company’s tax rate is 30% and the project’s cost of capital is 11%.
(a)    Prepare a schedule of relevant cash flows expected from this project. (12 marks)
(b)   Calculate the project NPV. (4 marks)
(c)    Advise management with reasons on whether they should or should not invest in this project. (4 marks)

Answer 1

[1] [9] [10] Year PVF @ 11% Present Value 1 2 [2] Additional Revenue on Sales $ 32,000.00 $ 32,000.00 $ 32,000.00 $ 32,000.00 $ 32,000.00 $ 32,000.00 $ 32,000.00 $ 32,000.00 $ 32,000.00 [3] [4]=[2+3] [5] [6]=[4-5] [7] [8]=[6+7] Additional Net Profit Tax Benefits on Revenue on Cash Flow After Tax Depriciation Foods & Drinks Net Profit Tax @ 30% $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 $ 20,000.00 $ 52,000.00 $ 15,600.00 $ 36,400.00 $ 6,000.00 $ 42,400.00 Presnt Value of Cash flow 0.901 $ 38,198.20 0.812 $ 34,412.79 0.731 $ 31,002.51 0.659 $ 27,930.19 0.593 $ 25,162.34 0.535 $ 22,668.77 0.482 $ 20,422.32 0.434 $ 18,398.48 0.391 $ 16,575.21 $ 234,770.82 6 7 8 9 Residual Value (30000*0.391) $ 11,727.74 $ 246,498.56 Equipment Cost Add: Additional Inventory $ 180,000.00 $ 15,000.00 $ 195,000.00 NPV $ 51,498.56 Management should invest in new equipment for this they can get present value of cash flow $246,498.56 compare to investment in Equipment and Inventory for $195,000