Question

A divisional manger, John James, expects to retire in three years. John is paid a fixed salary plus 10 percent of his division’s profits. Make the unrealistic assumption that John cares only about cash compensation. He can spend $200,000 on process improvements this year and that will yield $125,000 of cost savings for each of the following four years.

Use Excel and show all work—use formulas where useful

Required:            

1. Illustrate the case flows for seven years.
2. Should John James accept the project; why?
3. What are the short-term consequences of rejection of this project.
4. Illustrate the case flows for the new manager for years 4-7 if the project is accepted.

Answer 1

1.

Assuming Discounting factor to be 10 %

Year	Cash Flow	Present Value Factor@10%	Discounted Cash Flows
1	125000	0.909	113636.3636
2	125000	0.826	103305.7851
3	125000	0.751	93914.35011
4	125000	0.683	85376.68192
5	0	0.621	0
6	0	0.564	0
7	0	0.513	0
TOTAL		4.868	396233.18

2.

NPV @ 10%
Particulars	Amount
Cash Outflow
Cost of improvement	200000
Cash Inflow
Note1	396233.18
Net Present Value	196233.1808
(Inflow - Outflow)

As the NPV of the project is positive , james should accept the project.

3. If this project is not accepted company may loose annual savings of 125000 for each of the four years.

4. if project is accepted, cash flows for 4-7 years, for the new manager

Year	Cash Flow	Present Value Factor@10%	Discounted Cash Flows
4	125000	0.683	85376.68192
5	0	0.621	0
6	0	0.564	0
7	0	0.513	0
TOTAL		2.382	85376.68

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