Question

1. A new machine will cost $600,000 including delivery and installation. The new unit has a CCA depreciation rate of 25 percent. At the end of four years, it will be sold for $100,000. The net working capital requirement required at the beginning of the first four years are $50,000, $60,000, $70,000, and $60,000.

   In the first year, revenue will increase by $150,000 and operating costs will decrease by $30,000. The difference between them, R−C, will grow at 3 percent. The tax rate is 30 percent, and the discount rate is 14 percent.

   (a) How will R − C in the next four years affect the project’s NPV?
   (b) How will the PVCCATS and the proceeds from the sale at the end of year 4 affect the project’s NPV?

   (c) How will net working capital in the next four years affect the project’s NPV? (d) What is the free cash flow in year 1?

   (e) What is the NPV of the project?

Answer 1

	Particulars	Year 1	Year 2	Year 3	Year 4	Total
a	R-C	185400	190962	196691	202592
b	Depreciation' ( 600000*.25)	150000	112500	84375	63281	410156
c	Operating Income ( a-b)	35400	78462	112316	139310
d	Tax @ 30% ( c* .3)	10620	23539	33695	41793
e	Operating Profit after tax ( c-d)	24780	54923	78621	97517
f	Cash Flow ( e+b)	174780	167423	162996	160798
g	Proceeds from machine				100000
h	Loss on Machine				89844
i	Net Working Capital	50000	60000	70000	60000
j	Discounting Factor	0.877193	0.769468	0.674972	0.59208
k	PV OF CASH FLOWS ( f *j)	153316	128827	110018	95206
l	PV OF NET WORKING CAPITAL (I * j)	43860	46168	47248	35525
m	PV OF PROCEEDS OF THE MACHINE( g*j)				59208
n	TAX SHIELD ON LOSS ( h* 0.3)				26953.2
o	PV OF TAX SHIELD ON LOSS ( n*j)				15958

a) Revenue will increase by 150000 and operating expenses will decrease by 30000 ie

The total revenue earned on the machine = 150000 - ( 30000)

= $180,000 which will increase @ 3%.

This $180000 (R-C) will increase the NPV as it will increase the PV of Inflows and hence the Npv

b) The Deprection each year will give tax shield which will increase the PV of inflows and hence the Npv.

The total depreciation charged on machine = 410156

The Price of machine = 600000

Proceeds on the machine = 100000

Loss on the machine = 600000 - 410156 - 100000

= 89844

This loss will provide a tax shield in YEAR 4 = 89844 * .3 = 15958

The sale will increase the Pv of cash inflows and hence the npv

c) The net working capital in the next four years will increase the cash outflows and hence reduce the npv.

d)

Free cash flow = cash flow - increase in net working cap - cap expenditures

= 174780 - 50000 - 600000

= ($475220)