Question

Question 3 – Capital Investment Analysis

The management team of Accent Group Limited have received a proposal from the manager of Hype DC. This proposal concerns a major upgrade to Hype DC's stores to improve the customer experience. Key details relating to this proposal include:

• The initial cost will be $22 million. This cost will be depreciated using the straight line method over the 5 year life of the upgrade.
• During year 1, the firm will increase marketing costs by $2.0 million to promote the store upgrades.
• Over the five year life of the project, it is expected that the upgrade will increase the firm's sales by $18 million per year. On average, cost of sales is 45% of revenue.
• The firm will need to higher additional staff over the life of the project to help to deal with the increased sale volume. In year 1, the firm's staffing costs will increase by $1.0 million. These costs will increase by 3.5% p.a.
• The upgrade is expected to increase the firm's energy costs by $500,000 in year 1. This increase will be ongoing across the life of the project and will increase by 6% p.a.
• Upgraded stores will include an old shoe recycling drop off zone. This recylcing program will cost $75,000 in year 1. These costs will increase by 2% p.a.
• At the end of year 3, the firm will spend $1.5 million on a minor refurbishment to the stores.

The firm’s tax rate is 30%. The firm requires a 16% required rate of return on all potential investments.

Required

In relation to the above proposal:

1. Calculate the annual after tax cash flows and annual after tax profit

(show with workings please)

Answer 1

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Sales	1,80,00,000	1,80,00,000	1,80,00,000	1,80,00,000	1,80,00,000	9,00,00,000
Total Revenue	1,80,00,000	1,80,00,000	1,80,00,000	1,80,00,000	1,80,00,000	##########
Less : Cost of Goods Sold	81,00,000	81,00,000	81,00,000	81,00,000	81,00,000	4,05,00,000
Less : Marketing Cost	20,00,000					20,00,000
Less : Employment Cost	10,00,000	10,35,000	10,71,225	11,08,718	11,47,523	53,62,466
Less : Energy Cost	5,00,000	5,30,000	5,61,800	5,95,508	6,31,238	28,18,546
Less : Old Shoe Drop Off Zone Cost	75,000	76,500	78,030	79,591	81,182	3,90,303
Less : Minor Refubrishment to Stores			15,00,000			15,00,000
Total Expenses - Through Cash / Bank	1,16,75,000	97,41,500	1,13,11,055	98,83,816	99,59,944	##########
						-
Net Profit before Depreciation	63,25,000	82,58,500	66,88,945	81,16,184	80,40,056	3,74,28,685
Less : Depreciation	44,00,000	44,00,000	44,00,000	44,00,000	44,00,000	2,20,00,000
Net Profit after Depreciation	19,25,000	38,58,500	22,88,945	37,16,184	36,40,056	##########
Less : Firm Tax @ 30% on Net Profit after Depreciation	5,77,500	11,57,550	6,86,684	11,14,855	10,92,017	46,28,605
After Tax Profit	13,47,500	27,00,950	16,02,262	26,01,328	25,48,039	##########
Annual Rate of Return	6.13%	12.28%	7.28%	11.82%	11.58%
Cash Flow
Revenue Generated	1,80,00,000	1,80,00,000	1,80,00,000	1,80,00,000	1,80,00,000	9,00,00,000
Less : Expenses Incurred	1,16,75,000	97,41,500	1,13,11,055	98,83,816	99,59,944	5,25,71,315
Less : Initial Cost Incurred for the Project	2,20,00,000					2,20,00,000
Less : Tax Expense	5,77,500	11,57,550	6,86,684	11,14,855	10,92,017	46,28,605
Annual After Cash Flow	-1,62,52,500	71,00,950	60,02,262	70,01,328	69,48,039	##########
As can be seen above the annual Rate of Return is below 16% which the company has expected on its investment