Question

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Tahlia fashions specialises in clothing alterations and repairs. With a slogan of ‘You ask, we sew’, they pride themselves in the fact that they deliver quick, quality work, and that no request is too big or too small for them. They have built up quite a strong reputation in the community where they are located, and are looking to expand their reach to customers outside of the traditional borders of their business.

      As part of their expansion plan, they are looking to replace some of their outdated sewing machines with state-of-the-art, heavy-duty, industrial sewing machines. The new machinery costs R150 000 and with installation cost of R10 000. Tahlia can sell their old machines for a total of R40 000, but must deliver them to the buyer at a cost of R2 500. Tahlia originally bought the machines 4 years ago for a total of R80 000, and was depreciated on a straight-line basis over a period of 5 years. The firm is subject to a 28% tax rate. The capital expenditure results in an increase in net working capital of R18 000.

a)Determine the initial investment of Tahlia’s capital expenditure or initial investment.

b)Assume that this new investment made by Tahlia can be depreciated on a straight-line basis over a 5 year period. The firm has made the following projections of the expected incremental increases in net operating profit after taxes (NOPAT) for the 5-year life of the investment:

Year	Expected increase in NOPAT
1	R36 500
2	R30 000
3	R22 000
4	R9 000
5	R7 000

      Determine the expected operating cash inflows for Tahlia’s firm for each of the 5 years.

      (use table below), or create your own table.

Year	Expected increase in NOPAT	Depreciation	Expected operating cash inflows
1
2
3
4
5

c)Assume it is 4 years after Tahlia the purchased the new machine, she sells it to a competitor for R48 000. The net working capital of R18 000 is recovered and the firm is still subject to a 28% tax rate. Calculate the terminal cash flow of this investment as well as the net cash flow for Tahlia for Year 4.

Answer 1

(a)

Initial Investment = (Cash out flow for new machine - Cash inflow from old machine) + Increase in working capital

= (R160,000 - R31,480) + R18,000

= R146,520

Calculation of out flow of new machine (Cost) = Cost + Installation Expenses = R150,000 + R10,000 = R160,000

Increase in working capital = R18,000

Cash inflow from old machine = Cash flow from salvage value of old machine - Tax on Capital gain

= R37,500 - R6,020

= R31,480

Cash flow from salvage value of old machine = Selling value - expenses = R40,000 - R2,500 = R37,500

Tax on capital gain = {cash flow from Salvage - (cost - accumulated depreciation)} x 28%

= {R37,500 - [R80,000 - (R80,000 x 4/5)] x 28%

= {R37,500 - (R80,000 - R64,000)} x 28%

= (R37,500 - R16,000) x28%

= R6,020

(b)

Year	Expected increase in cashflow	Depreciation	Expected operating cash inflows
1	R36,500	R32,000	R68,500
2	R30,000	R32,000	R62,000
3	R22,000	R32,000	R54,000
4	R9,000	R32,000	R41,000
5	R7,000	R32,000	R39,000

Depreciation = Cost / Years = R160,000 / 5 = R32,000

(c)

4th Year Cash flow = Terminal Cash Flow + Expected operating cash flow = R61,520 + R41,000 = R102,520

Book Value = Cost - Accumulated depreciation = R160,000 - R128,000* = R32,000 (*R32,000 x 4 = R128,000)

Tax on disposal = (Proceeds received on disposal - Book value) x 28% = (R48,000 - R32,000) x 28% = R4,480

If any help require then please comment i will help you.

Terminal Cash Flow Particular Actual proceeds received on disposal book value on disposal Tax rate on disposal Tax on disposal After tax proceeds on disposal of machine Release of working capital Terminal Cash Flow Amount R48,000 R32,000 28% R4,480 R43,520 R18,000 R61,520