Question

Problem 1
Zmolek Company is considering the purchase of a machine costing ₱700,000 with a useful life of 10 years. Annual cash cost savings are expected to be ₱200,000. Zmolek's income tax rate is 40% and its cost of capital is 12%. Zmolek expects to use straight-line depreciation for tax purposes.
Required:
1. Compute the expected increase in annual net cash flow for this project.
2. Compute the profitability index for the project.

Problem 2
Racine Co. has the opportunity to introduce a new product. Racine expects the project to sell for ₱200 and to have per-unit variable costs of ₱130 and annual cash fixed costs of ₱6,000,000. Expected annual sales volume is 125,000 units. The equipment needed to bring out the new product costs ₱7,200,000, has a fouryear life and no salvage value, and would be depreciated on a straight-line basis. Working capital of ₱500,000 would be necessary to support the increased sales. Racine's cost of capital is 12% and its income tax rate is 40%.
Required:
1. Compute the NPV of this opportunity.
2. Compute the profitability index of this opportunity.

Answer 1

Q1)		Yr0	Yr1	Yr2	Yr3	Yr4	Yr5	Yr6	Yr7	Yr8	Yr9	Yr10
	Cost	(700,000)
	Savings		200,000	33,000	33,000	33,000	33,000	33,000	33,000	33,000	33,000	33,000
	Depreciation	(70,000)	(70,000)	(70,000)	(70,000)	(70,000)	(70,000)	(70,000)	(70,000)	(70,000)	(70,000)	<---700000/10
	Gross savings	130,000	(37,000)	(37,000)	(37,000)	(37,000)	(37,000)	(37,000)	(37,000)	(37,000)	(37,000)	<--Savings-depreciation
	Tax @40%	(52,000)	14,800	14,800	14,800	14,800	14,800	14,800	14,800	14,800	14,800	<--Gross savings*40%
	After tax savings	78,000	(22,200)	(22,200)	(22,200)	(22,200)	(22,200)	(22,200)	(22,200)	(22,200)	(22,200)	<--Gross savings-tax
	Add depreciation	70,000	70,000	70,000	70,000	70,000	70,000	70,000	70,000	70,000	70,000	<--Depreciation aded back as it is a non cash expense
	Net Cash Flows	(700,000)	148,000	47,800	47,800	47,800	47,800	47,800	47,800	47,800	47,800	47,800	<--After tax savings+depreciation
	Profitability Index	0.83	<--Sum of net cashflows from yr1-10/Cash outflow at yr0
Q2)
	Price/unit	200	200	200	200
	Cost unit		130	130	130	130
		Yr0	Yr1	Yr2	Yr3	Yr4
	Cost	(7,200,000)
	Sales		25,000,000	25,000,000	25,000,000	25,000,000	<--125000*price/unit
	Variable costs	(16,250,000)	(16,250,000)	(16,250,000)	(16,250,000)	<--125000*cost/unit
	fixed costs	(6,000,000)	(6,000,000)	(6,000,000)	(6,000,000)
	Operating cash flows	2,750,000	2,750,000	2,750,000	2,750,000	<--Sales-variable cost-fixed cost
	Deprecition	(1,800,000)	(1,800,000)	(1,800,000)	(1,800,000)	<--7200000/4
	Profit before tax	950,000	950,000	950,000	950,000	<--Operating Profit-Depreciation
	Tax @40%	(380,000)	(380,000)	(380,000)	(380,000)	<--Profit before tax*40%
	Profit after tax	570,000	570,000	570,000	570,000
	Add deprecations	1,800,000	1,800,000	1,800,000	1,800,000	<--Depreciation aded back as it is a non cash expense
	Remove WC	(500,000)
	Net cashflows	(7,700,000)	2,370,000	2,370,000	2,370,000	2,370,000
	NPV @12%	(501,482.05)	<--Using NPV formula of excel
	Profitability Index	1.23	<--Sum of net cashflows from yr1-4/Cash outflow at yr0

The above table gives answers to the two questions along with the case facts.

But better readability copy to excel

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