Question

Excerpt Pulp and Paper Limited (EPP) wants to expand its operations. It is considering the purchase of a mulching and pressing machine for its new line of paper worth $600,000. The company estimates that the equipment will enable them to increase revenues by $750,000 per year for the next five (5) years, which is also the useful life of the equipment. Variable operating expenses related to the pressing machine are estimated to be 55% of revenues per year and fixed expenses associated with the project are $75,000 per year.

The new mulching and pressing machine is much bigger and will need to be located in a different location of EPP operations. They will use an existing facility that is currently underused and leased out for $55,000 per year. EPP bought this facility for $1.1 million two years ago.

At the end of its useful life, management believes the machine can be sold (salvage value) for $50,000. EPP will require $17,500 of net working capital for this project which will be recovered at the end of the project.

The company uses a discount rate of 10% for projects of similar risk, and their marginal tax rate is 30%.

Use the net present value (NPV) method to evaluate the project.

Decision: Should the company accept or reject the project? (You must show your work for full marks)

(Note: fill in the cells in the table in the following page with appropriate ‘item name’ such as Revenue, Fixed Costs, Variable Costs, Depreciation, and Lost revenues)

Year	0	1	2	3	4	5
Fill in this cell
Fill in this cell
Fill in this cell
Fill in this cell
Fill in this cell
Earnings before tax
Income Tax @ 30%
Earnings after tax
Add: Depreciation
Capital Expenditures
Changes in Net Working Capital
Free Cash flows
NPV

could you please fill in the chart above

Answer 1

Tax rate		30%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		$       600,000	$      600,000	$       600,000	$       600,000	$      600,000
Dep Rate (1/5=20%)		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation	Cost * Dep rate	$       120,000	$      120,000	$       120,000	$       120,000	$      120,000	$       600,000
Calculation of after-tax salvage value
Cost of machine			$      600,000
Depreciation			$      600,000
WDV	Cost less accumulated depreciation	$                -
Sale price			$        50,000
Profit/(Loss)	Sale price less WDV	$        50,000
Tax	Profit/(Loss)*tax rate	$        15,000
Sale price after-tax	Sale price less tax		$        35,000
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
Sale		$       750,000	$      750,000	$       750,000	$       750,000	$      750,000
Less: Operating Cost @ 55%		$       412,500	$      412,500	$       412,500	$       412,500	$      412,500
Contribution		$       337,500	$      337,500	$       337,500	$       337,500	$      337,500
Less: Fixed cost		$         75,000	$        75,000	$         75,000	$         75,000	$        75,000
Less: lost revenue		$         55,000	$        55,000	$         55,000	$         55,000	$        55,000
Less: Depreciation		$       120,000	$      120,000	$       120,000	$       120,000	$      120,000
Profit before tax (PBT)		$         87,500	$        87,500	$         87,500	$         87,500	$        87,500
Tax@30%	PBT*Tax rate	$         26,250	$        26,250	$         26,250	$         26,250	$        26,250
Profit After Tax (PAT)	PBT - Tax	$         61,250	$        61,250	$         61,250	$         61,250	$        61,250
Add Depreciation	PAT + Dep	$       120,000	$      120,000	$       120,000	$       120,000	$      120,000
Cash Profit after-tax		$       181,250	$      181,250	$       181,250	$       181,250	$      181,250
Calculation of NPV
						10.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$     (600,000)	$       (17,500)		$     (617,500)	1.0000	$     (617,500)
1				$       181,250	$       181,250	0.9091	$       164,773
2				$       181,250	$       181,250	0.8264	$       149,793
3				$       181,250	$       181,250	0.7513	$       136,176
4				$       181,250	$       181,250	0.6830	$       123,796
5		$         35,000	$        17,500	$       181,250	$       233,750	0.6209	$       145,140
					Net Present Value	$       102,178