Question

You must evaluate a proposal to buy a new milling machine with purchase price of $150,000. The machine will be depreciated to zero value over the 4 years using prime cost (straight line) method. The machine would be sold after 4 years for $70,000.

Inventory will increase by $17,000 and account payables will rise by $7,500. All other working capital components will stay the same, so the change in net working capital is $9,500. The managers expect to fully recover the working capital of $9,500 at the end of the project (year 4).

The pretax labor costs would decline by $50,000 per year.

Below shows the forecasted sales revenues, variable cost and fixed cost.

	Year 1	Year 2	Year 3	Year 4
Sales quantity (units)	2,500	3,000	3,500	4,000
Selling price per unit	$3	$3.1	$3.2	$3.3
Fixed cost of production (per year)	$2,000	$2,100	$2,200	$2,300
Variable cost of production (per unit)	$1.1	$1.2	$1.25	$1.35

The marginal tax rate is 35% and the discount rate is 10.5%.

1. What is the net present value (NPV) of the proposal? (please provide workings)
2. Advise should the project be accepted based on your answer in part (i)? (please provide workings)

   Please set out your work clearly and neatly. If you choose you can take advantage of the table below or you can continue your workings on the following page which has been intentionally left blank.

3. THIS PAGE IS LEFT BLANK PAGE FOR YOUR WORKINGS

Answer 1

	Year 0	Year 1	Year 2	Year 3	Year 4
Purchase Price	-150000
Working Capital Introduced	-9500
Sales		7500	9300	11200	13200
(Sales Qty * Selling Price per unit)
Less : Variable Cost		2750	3600	4375	5400
(Sales Qty * Variable Cost per unit)
Less : Fixed Cost		2000	2100	2200	2300
Less : Depreciation		37500	37500	37500	37500
(150000/4)
Add : Saving in labour Cost		50000	50000	50000	50000
Earning before Tax		15250	16100	17125	18000
Less : Tax @35%		5337.5	5635	5993.75	6300
Earning After Tax		9912.5	10465	11131.25	11700
Add : Depreciation		37500	37500	37500	37500
Add : Salvage (net of tax)					45500
[70000*(1-0.35)]
Cash Flows	-159500	47412.5	47965	48631.25	94700
[email protected]%	1	0.904977	0.818984	0.741162	0.670735
PV of Cash flows	-159500	42907.24	39282.57	36043.64	63518.59

(i) NPV = PV of Cash Inflow - Cash Outflow

= (42907.24+39282.57+36043.64+63518.59) - 159500

= 181752 - 159500 =22252.04

NPV = 181752 -159500 ==> 22252.04

(ii) project should be accepted as NPV is +ve