Question

Mr. Nihal representing M/s. Raymobile Motors which is a very profitable company. It needs financial analysis of an investment in a new production machine for Rs. 1000,000. The purchase of this machine will result in an increase in sales revenues of Rs. 425,000 in the first year and the associated expenses (excluding depreciation) are 25% of the revenues. The revenues will be growing at 10% PA. They will incur Rs 25,000 as consultancy fee to the Professor. Because of the new machine overheads will increase by Rs 20,000 pa. Working capital required during the operational life of the project @ 5% of the next-year sales to be invested at the beginning of the year. It will be recovered after the useful life of the machine which is 5 years. Assume straight-line depreciation, that this machine is being depreciated down to zero, a 35 percent marginal tax rate, and a required rate of return of 12 percent.

What will be the recommendation to Nihal? Show the initial investment, annual operating cashflow and the terminal cashflow.

Answer 1

Summary:

1.Calculate all cash inflows year wise for 5 years after tax and add back depreceation to get net cashinflows

2. Discount the cash flows at required rate of return that is @12% in this case

3. Calculate initial investment including working capital which is year wise investment and discounted to get present value.

4.calculate terminal cash inflow

5 calculate NPV by deducting Outflows from inflows