Question

DIY is considering a project that lasts for 9 years. The company currently has debt/equity ratio of 0.25, cost of equity of 15.58%, and cost of debt of 5%. The project requires a machine that costs $96,000 and has a CCA rate of 35%. The salvage value is $12,000 at year 9 and the asset class terminates since the machine is the only asset in the class. The machine will generate $32,000 before-tax cash flow in the first year, which grows at 5% per year. The corporate tax rate is 40%. The project will be financed by 80% internal equity and 20% new borrowing. Due to the pandemic, the government will offer a subsidized loan at 3% but require repaying 30%, 40% and 30% of the loan at the end of year 7, 8 and 9, respectively. The flotation cost of new borrowing is 6%.

1.What is the NPV of the project? (Use the APV method)

Answer 1

1. Required Rate of Return (Cost of Capital to be used in New Project) = Weight * Cost of Capital

Required Rate of Return = 0.80 * 15.58% + 0.20 * 3%

= 12.46% + 0.60%

= 13.06%

2. Calculation of Depreciation and WDV at every year

Year	Opening WDV	Depreciation	Closing WDV
1	96,000.00	16,800.00	79,200.00
2	79,200.00	27,720.00	51,480.00
3	51,480.00	18,018.00	33,462.00
4	33,462.00	11,712.00	21,750.00
5	21,750.00	7,613.00	14,137.00
6	14,137.00	4,948.00	9,189.00
7	9,189.00	3,216.00	5,973.00
8	5,973.00	2,091.00	3,882.00
9	3,882.00	1,359.00	2,523.00
		93,477.00

Profit on Sale of Fixed Assets = 12000 - 2523 = 9477

3. Discounted Cash Flows

Year	1	2	3	4	5	6	7	8	9
Cash Flows	$        32,000.00	$         33,600.00	$         35,280.00	$         37,044.00	$        38,896.00	$        40,841.00	$         42,883.00	$         45,027.00	$           47,278.00
Profit on Sale of Machine	-	-	-	-	-	-	-	-	$              9,477.00
Interest Cost	$        576.00	$         576.00	$         576.00	$         576.00	$        576.00	$        576.00	$         576.00	$         403.20	$           172.80
Depreciation	$     16,800.00	$      27,720.00	$      18,018.00	$      11,712.00	$        7,613.00	$        4,948.00	$        3,216.00	$        2,091.00	$           1,359.00
Profit before Tax	$     14,624.00	$        5,304.00	$      16,686.00	$      24,756.00	$     30,707.00	$     35,317.00	$      39,091.00	$      42,532.80	$        55,223.20
Less: Tax @ 40%	$       5,850.00	$        2,122.00	$        6,674.00	$        9,902.00	$     12,283.00	$     14,127.00	$      15,636.00	$      17,013.00	$        22,089.00
Profit after Tax	$       8,774.00	$        3,182.00	$      10,012.00	$      14,854.00	$     18,424.00	$     21,190.00	$      23,455.00	$      25,519.80	$        33,134.20
Add: Depreciation	$ 16,800.00	$   27,720.00	$   18,018.00	$   11,712.00	$     7,613.00	$     4,948.00	$     3,216.00	$     2,091.00	$     1,359.00
Less: Profit on Sale of Machine	-	-	-	-	-	-	-	-	$     9,477.00
Less: Repayment of Loan	-	-	-	-	-	-	$     5,760.00	$     7,680.00	$     5,760.00
Add: Salvage Value of Machine	-	-	-	-	-	-	-	-	$        12,000.00
Cash Flows from Project	$ 25,574.00	$   30,902.00	$   28,030.00	$   26,566.00	$ 26,037.00	$ 26,138.00	$   20,911.00	$   19,930.80	$ 31,256.20
Present Value Factor @ 13.06%	0.8845	0.7823	0.6919	0.6120	0.5413	0.4788	0.4235	0.3746	0.3313
Discounted Cash Flows	$ 22,620.00	$   24,175.00	$   19,394.00	$   16,258.00	$ 14,094.00	$ 12,515.00	$ 8,856.00	$ 7,466.00	$ 10,355.00

4. Calculation of NPV

NPV = Total Discounted Cash Flows - Initial Cash Outflows

= $135,733 - $ 96,000 = $39,733