Question

To please be done in excel: It is November, 2001. ABC Ltd. is a company listed on the Stock Exchange. The company was founded in the early 1980’s and management identified a market for small photocopier and fax machines and in later years, tablets. The company has in the past relied on importing equipment from the Far East, but the recent decline in the value of the Peso, combined with increased local competition, has resulted in a significant decrease in the profitability during the past two years. Management is investigating the feasibility of establishing a local manufacturing plant in order to manufacture a new, low cost tablet called “Tab”. This machine would be the only tablet supplied by ABC. It is a small and fairly basic machine, which is designed to serve the lower end of the market. Based on a market survey (which cost $100 000), the probable demand for “Tab” in the first year has been estimated. This is illustrated in Table 1. Table 1: Market Survey of Expected Demand in Year 1 Demand per annum Probability Expected Demand High 10,000 30% Medium 9,400 40% 9400 Low 8,800 30% New plant with a maximum annual capacity of 10 000 units can be purchased for $3.5 million. The plant has an estimated useful life for four years, at the end of which the residual value is expected to be $350 000. Variable production costs are estimated at $1 000 per unit, while additional fixed costs, based on a capacity of 10 000 units and before allowing for depreciation, are expected to amount to $250 per unit. These fixed costs will be avoidable if local manufacture does not take place. The “Tab” would sell for $1 700 each, some $500 less than the selling price of the cheap imported tablets currently sold by ABC. This would mean that the current sales of 7 000 units per annum of the cheap imported machines would cease. The contribution generated by sale of these imported machines amounts to $250 per unit. Existing fixed costs amount to $1,75 million per annum, and will still be incurred if local manufacture takes place. The new plant would be written off over 5 years on a straight-line basis for tax purposes. The corporate tax rate is 30% and ABC uses a discount rate of 18% for all projects of this type. There are no expected changes to the working capital of the business. Question: Show that the project’s expected net incremental cash flows for the first year are equal to $1 316 000.Assuming that all four years have the same net incremental cash flows as calculated, and taking into account any other relevant cash flows, show that the NPV, IRR and Payback Period of the project as a whole are: $274 805.27, 21.8% and 2.66 years respectively.

Answer 1

Answer )

Demand(D)	Probability(P)	P*D
10,000	0.3	3000
9400	0.4	3760
8800	0.3	2640
	Total Demand	9400

Increamental cost , when they are importing to sell.

Increamental Cost
Revenue(@ 1700 per unit sales)	$15,980,000
Variable cost(with contribution /unit)	($11,750,000)
Fixed cost(@ 250 /unit)	($2,350,000)
Total income before tax	$1,880,000
Depreciation
Total annual flow for tax	$1,880,000
Income tax	($564,000)
Net cash flow	$1,316,000

	0	y1	y2	Y3	Y4
Cash out flow
Cost of market survey	($100,000)
Cost of acquisition	($3,500,000)
	($3,600,000)
Revenue(@ 1700 per unit sales)		$15,980,000	$15,980,000	$15,980,000	$15,980,000
Contribution (@ 250 /unit)		$2,350,000	$2,350,000	$2,350,000	$2,350,000
Sells of machine					$350,000
Variable cost(@1000/unit)		($9,400,000)	($9,400,000)	($9,400,000)	($9,400,000)
Fixed cost(@ 250 /unit)		($2,350,000)	($2,350,000)	($2,350,000)	($2,350,000)
Addition fixed cost		($1,750,000)	($1,750,000)	($1,750,000)	($1,750,000)
Total income before tax		$4,830,000	$4,830,000	$4,830,000	$5,180,000
Depreciation		($700,000)	($700,000)	($700,000)	($700,000)
Total annual flow for tax		$4,130,000	$4,130,000	$4,130,000	$4,480,000
Income tax		($1,239,000)	($1,239,000)	($1,239,000)	($1,344,000)
Net income		$3,591,000	$3,591,000	$3,591,000	$3,836,000
PV (Net Income)		$2,499,165	$1,739,300	$1,210,470	$899,905
NPV		$2,748,839	(very near to given figure)

Pay back 2 year 237 days = 2.66 year (aprox)