Question

• Company ABC is considering a ₤200,000 outlay for fixed capital items. This outlay includes ₤25,000 for land, plus ₤175,000 for equipment. Depreciation policy is straight-line to zero after five years. Capital allowance/Tax Writing Down Allowance is 20% per annum. The project requires ₤50,000 of current assets and ₤30,000 in current liabilities at the onset. • In Year 1, sales will be ₤220,000. They grow at 25% for the next two years and then grow at 10% for the last two years. Fixed cash operating expenses will be ₤30,000 for Years 1-3 and ₤20,000 for Years 4-5. Variable cash operating expenses are 30% of sales in Year 1, 40% of sales in Year 2 and 35% of sales in Years 3 to 5. Company X’s marginal tax rate is 30% and required rate of return is 10%. • At the end of year 5, the company will sell off the fixed capital investments for ₤50,000 and recapture its cumulative investment in net working capital. Income taxes will be paid on any gains. Assume that all cash flows arise at the end of the year. • Required: Determine whether this project is profitable using the NPV.

Answer 1

	0	1	2	3	4	5
Initial investment:
Land	25000
Equipment	175000
NWC (50000-30000)	20000
Operating cash flows:
Sales		220000	275000	343750	378125	415938
Fixed cash operating expenses		30000	30000	30000	20000	20000
Variable cash operating expenses		66000	110000	120313	132344	145578
Depreciation (175000*20%)		35000	35000	35000	35000	35000
NOI		89000	100000	158438	190781	215359
Tax at 30%		26700	30000	47531	57234	64608
NOPAT		62300	70000	110906	133547	150752
Add: Depreciation		35000	35000	35000	35000	35000
OCF		97300	105000	145906	168547	185752
After tax salvage value [50000-(50000-25000)*30%]						42500
Recovery of NWC						20000
Annual after tax project cash flows	-220000	97300	105000	145906	168547	248252
PVIF at 10% [1/1.1^n]	1	0.90909	0.82645	0.75131	0.68301	0.62092
PV at 10%	-220000	88455	86777	109622	115120	154145
NPV	334117
THE PROJECT IS PROFITABLE AS ITS NPV IS POSITIVE.