Question
In: Finance
ABC Ltd. is a computer manufacturer and has just received the results of a market research...
ABC
Ltd. is a computer manufacturer and has just received the results
of a market research study to determine if the company should
introduce a new product line. The expected duration of the project
is 6 years. The cost for market research study is $150,000. Sue is
the project manager and she has gathered the following information:
• Annual cash sale is $600,000 in the first two years, and starts
to increase by 4% per year thereafter Expected costs is 35% of
sales Other relevant data for cash flows estimation is as follow: -
The market research study indicated a market exists, however, if
the company proceeds with the new product line they estimate they
will lose sales to the value of $150,000 in the first year,
$100,000 in the second year, and $50,000 in the third year on their
existing products. - Working capital is estimated as 10% of sales.
All of the net working capital will be recovered at the end of the
project. - The initial cost for necessary machining equipment is
$1,400,000, plus the installation cost of $100,000. The equipment
will be depreciated at the rate of 18% p.a. in the first four
years, and 15% p.a. in year 5 and year 6. The firm expects to sell
the equipment for $250,000 at the end of the project. - The company
plans to set up its new operation in its own building, which was
purchased last year at a cost of $3,000,000. The building site can
be leased for $3,500 per month payable in arrears - Corporate tax
rate is 28%, and discount rate is 12%. - Require: Using the NPV
method, evaluate whether ABC Ltd should proceed with the
project?
Solutions
Expert Solution
| Tax rate | 28% | |||||||
| Calculation of annual depreciation | ||||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Year-6 | Total | |
| Cost (1400000+100000) | $ 1,500,000 | $ 1,500,000 | $ 1,500,000 | $ 1,500,000 | $ 1,500,000 | $ 1,500,000 | ||
| Dep Rate | 18.00% | 18.00% | 18.00% | 18.00% | 15.00% | 0.00% | ||
| Depreciation | Cost * Dep rate | $ 270,000 | $ 270,000 | $ 270,000 | $ 270,000 | $ 225,000 | $ 195,000 | $1,500,000 |
| Last year depreciation @ 18% comes to $ 225,000 but the depreciation charge will be limited to $ 195,000. | ||||||||
| Calculation of after-tax salvage value | ||||||||
| Cost of machine | $ 1,500,000 | |||||||
| Depreciation | $ 1,500,000 | |||||||
| WDV | Cost less accumulated depreciation | $ - | ||||||
| Sale price | $ 250,000 | |||||||
| Profit/(Loss) | Sale price less WDV | $ 250,000 | ||||||
| Tax | Profit/(Loss)*tax rate | $ 70,000 | ||||||
| Sale price after-tax | Sale price less tax | $ 180,000 | ||||||
| Calculation of annual operating cash flow | ||||||||
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Year-6 | |||
| Sale | $ 600,000 | $ 600,000 | $ 624,000 | $ 648,960 | $ 674,918 | $ 701,915 | ||
| Less: Operating Cost @ 35% | $ 210,000 | $ 210,000 | $ 218,400 | $ 227,136 | $ 236,221 | $ 245,670 | ||
| Contribution | $ 390,000 | $ 390,000 | $ 405,600 | $ 421,824 | $ 438,697 | $ 456,245 | ||
| Less: lost contribution on lost sale @ 65% of sale | $ 97,500 | $ 65,000 | $ 32,500 | |||||
| Less: lease rental (3500*12) | $ 42,000 | $ 42,000 | $ 42,000 | $ 42,000 | $ 42,000 | $ 42,000 | ||
| Less: Depreciation | $ 270,000 | $ 270,000 | $ 270,000 | $ 270,000 | $ 225,000 | $ 195,000 | ||
| Profit before tax (PBT) | $ (19,500) | $ 13,000 | $ 61,100 | $ 109,824 | $ 171,697 | $ 219,245 | ||
| Tax@28% | PBT*Tax rate | $ (5,460) | $ 3,640 | $ 17,108 | $ 30,751 | $ 48,075 | $ 61,389 | |
| Profit After Tax (PAT) | PBT - Tax | $ (14,040) | $ 9,360 | $ 43,992 | $ 79,073 | $ 123,622 | $ 157,856 | |
| Add Depreciation | PAT + Dep | $ 270,000 | $ 270,000 | $ 270,000 | $ 270,000 | $ 225,000 | $ 195,000 | |
| Cash Profit after-tax | $ 255,960 | $ 279,360 | $ 313,992 | $ 349,073 | $ 348,622 | $ 352,856 | ||
| Calculation of working capital movement | ||||||||
| Working capital-opening | $ - | $ 60,000 | $ 60,000 | $ 62,400 | $ 64,896 | $ 67,492 | $ 70,192 | |
| Closing working capital | $ 60,000 | $ 60,000 | $ 62,400 | $ 64,896 | $ 67,492 | $ 70,192 | $ - | |
| Movement | $ 60,000 | $ - | $ 2,400 | $ 2,496 | $ 2,596 | $ 2,700 | $ (70,192) | |
| Calculation of NPV | ||||||||
| 12.00% | ||||||||
| Year | Capital | Working capital | Operating cash | Annual Cash flow | PV factor, 1/(1+r)^time | Present values | ||
| 0 | $ (1,500,000) | $ (60,000) | $ (1,560,000) | 1.0000 | $ (1,560,000) | |||
| 1 | $ - | $ 255,960 | $ 255,960 | 0.8929 | $ 228,536 | |||
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