Question

( show all work including formulars ) as a senior analyst for the company you have ... Question: Show Excel ( show all work including formulars ) As a senior analyst for the company you have bee... show Excel ( show all work including formulars ) As a senior analyst for the company you have been asked to evaluate a new IT software project. The company has just paid a consulting firm $50,000 for a test marketing analysis. After looking at the project plan, you anticipate that the project will need to acquire computer hardware for a cost of $400,000. The Australian Taxation Office rules allow an effective life for the computer hardware of five years. The equipment can be depreciated on a straight-line (prime cost) basis and there is no expected salvage value after the five years. Your company does not have any available space where the project can be located for five years and you anticipate a new office will cost $80,000 to rent for the first year. You expect that the project will need to hire 3 new software specialists at $50,000 (each specialist) in the first year for the full five years to work on the software. The project will use a van currently owned by the company and although the van is not currently being used by the company, it can be rented out for $5,000 per year for five years. The book value of the van is $20,000. The van is being depreciated straight-line (with five years remaining for depreciation) and is expected to be worthless after the five years. Expected annual marketing and selling costs will be incurred, with the first year expecting to be $200,000. The produced software is expected to sell at $100 per unit while the cost to produce each unit is $40. You expect that 10,000 units will be sold in the first year and the number of units sold will increase by 20% a year for the remaining four years. The project will need working capital of $50 000 to commence the business (in year 0) and the investment in working capital is to be completely recovered by the end of the project’s life (in year 5). The company tax rate is 30%, and the discount rate is 10%. Based on the information presented above, answer the following questions (1) – (3). 1. In evaluating the new IT software project, are the cost of $50,000 spent on marketing analysis and the use of van relevant for capital budgeting decision? Explain your answer(s). 2. Calculate the incremental free cash flow during the project’s life (at the end of Years 1 through 5). Show workings.\ 3. Calculate the NPV, payback period and IRR of the project. Should the project be accepted? Show workings and explain your answer(s).

Answer 1

1. The amount paid to the consulting firm of $ 50,000 is not relevant for capital budgeting decision as it is already paid irrespective of the project. Even if the is not accepted, these cost are paid and are sunk cost.

2.

INCREMENTAL CASH FLOWS
PARTICULARS	YEARS
	0	1	2	3	4	5
1. SALES
(a) SALES UNIT		10000.00	12000.00	14400.00	17280.00	20736.00
(b) PRICE PER UNIT		$                   100.00	$                   100.00	$                   100.00	$                   100.00	$                   100.00
SALES AMOUNT (a*b)		$       1,000,000.00	$       1,200,000.00	$       1,440,000.00	$       1,728,000.00	$       2,073,600.00
2. VARIABLE COST
VARIABLE COST PER UNIT		$                     40.00	$                     40.00	$                     40.00	$                     40.00	$                     40.00
VARIABLE COST AMOUNT		$          400,000.00	$          480,000.00	$          576,000.00	$          691,200.00	$          829,440.00
3. FIXED COST
RENT		$             80,000.00	$             80,000.00	$             80,000.00	$             80,000.00	$             80,000.00
SALARY		$          150,000.00	$          150,000.00	$          150,000.00	$          150,000.00	$          150,000.00
MARKETING		$          200,000.00	$          200,000.00	$          200,000.00	$          200,000.00	$          200,000.00
		$          430,000.00	$          430,000.00	$          430,000.00	$          430,000.00	$          430,000.00
4. DEPRECIATION
VAN = 20000/5		$               4,000.00	$               4,000.00	$               4,000.00	$               4,000.00	$               4,000.00
COMPUTER HARDWARE = 400000/5		$             80,000.00	$             80,000.00	$             80,000.00	$             80,000.00	$             80,000.00
		$             84,000.00	$             84,000.00	$             84,000.00	$             84,000.00	$             84,000.00
5. NET PROFIT		$             86,000.00	$          206,000.00	$          350,000.00	$          522,800.00	$          730,160.00
(1-2-3-4)
6. TAX EXPENSE		$             25,800.00	$             61,800.00	$          105,000.00	$          156,840.00	$          219,048.00
30% OF 5.
7. NET PROFIT AFTER TAX		$             60,200.00	$          144,200.00	$          245,000.00	$          365,960.00	$          511,112.00
(5. - 6. )
WORKING CAPITAL						$             50,000.00
8. AFTER TAX CASH FLOWS		$          144,200.00	$          228,200.00	$          329,000.00	$          449,960.00	$          645,112.00
(7. + 4. )

3. NET PRESENT VALUE

CASH FLOWS CALCULATIONS
PARTICULARS	YEARS
	0	1	2	3	4	5
1. INITIAL INVESTMENTS
COST OF EQUIPMENT	$            400,000.00
WORKING CAPITAL	$              50,000.00
	$            450,000.00
2. CASH FLOWS
CASH FLOWS FROM PROJECT		$                              144,200.00	$        228,200.00	$        329,000.00	$        449,960.00	$        645,112.00
3. DISCOUNTING FACTOR		0.90909	0.82645	0.75131	0.68301	0.62092
10.00%
4. DISCOUNTED CASH FLOWS		$                              131,090.91	$        188,595.04	$        247,182.57	$        307,328.73	$        400,563.80
(3.*2.)
5. NET PRESENT VALUE	$          (450,000.00)	$                              131,090.91	$        188,595.04	$        247,182.57	$        307,328.73	$        400,563.80	$ 824,761.05
(4. - 1.)

SHOW FORMULA IN EXCEL :

	0	1	2	3	4	5
1. INITIAL INVESTMENTS
COST OF EQUIPMENT	400000
WORKING CAPITAL	50000
	=SUM(B5:B6)
2. CASH FLOWS
CASH FLOWS FROM PROJECT		=+Sheet2!C38	=+Sheet2!D38	=+Sheet2!E38	=+Sheet2!F38	=+Sheet2!G38
3. DISCOUNTING FACTOR		=1/(1+0.1)^C3	=1/(1+0.1)^D3	=1/(1+0.1)^E3	=1/(1+0.1)^F3	=1/(1+0.1)^G3
0.1
4. DISCOUNTED CASH FLOWS		=+C10*C9	=+D10*D9	=+E10*E9	=+F10*F9	=+G10*G9
(3.*2.)
5. NET PRESENT VALUE	=-B5-B6	=+C12	=+D12	=+E12	=+F12	=+G12	=SUM(B14:G14)
(4. - 1.)

PAY BACK PERIOD

YEAR	CASH FLOW	NET INVESTED CASH FLOW
0		$                              450,000.00
1	$            131,090.91	$                           (318,909.09)
2	$            188,595.04	$                           (130,314.05)
3	$            247,182.57
4	$            307,328.73
5	$            400,563.80
	PAY BACK PERIOD IS BETWEEN 2 AND 3 YEARS.
	THERE IS $130,314.05 OF INVESTMENT YET TO BE PAID BACK AT THE YEAR 2 AND THERE IS $247,182.57 OF CASH FLOWS PROJECTED FOR YEAR 3
	PAY BACK PERIOD = 2 YEARS + 130314.05/247182.57
		2.52 YEARS

IRR

INTERNAL RATE OF RETURN

THE DISCOUNTING RATE AT WHICH NET CASH INFLOWS WILL BE EQUAL TO THE NET CASH OUTFLOWS =IRR(B19:G19)

38%