Question

DIY is considering a project that lasts for 9 years. The company currently has debt/equity ratio of 0.25, cost of equity of 15.58%, and cost of debt of 5%. The project requires a machine that costs $96,000 and has a CCA rate of 35%. The salvage value is $12,000 at year 9 and the asset class terminates since the machine is the only asset in the class. The machine will generate $32,000 before-tax cash flow in the first year, which grows at 5% per year. The corporate tax rate is 40%. The project will be financed by 80% internal equity and 20% new borrowing. Due to the pandemic, the government will offer a subsidized loan at 3% but require repaying 30%, 40% and 30% of the loan at the end of year 7, 8 and 9, respectively. The flotation cost of new borrowing is 6%. What is the NPV of the project? (Use the APV method)

Answer 1

Given capital borrowing options given

If 100%

cost of equity =0.25%

cost of debt=5%

debt :equity=15.28%

but finally DIY considered to bring capital as

80%=Equity, 20%=debt

so cost of new capital

(Cost of Capital for New Project) = 80% of equity+20%of debt

Cost of capital = 0.80 * 15.58% + 0.20 * 3%

= 12.46% + 0.60%

= 13.06%

2. Salvage value is given at end so depreciation to be find out and at end profit/loss transferred to profit and loss account

Here assumption taken is machinery purchased at the starting of the year so full depreciation provided

Calculation of Depreciation and WDV at every year @35%

Year	Opening WDV	Depreciation	Closing WDV
1	96,000	29,400	66,600
2	66,600	23,310	43,290
3	43,290	15,152	28,138
4	28,138	9,848	18,290
5	18,290	6,401	11,488
6	11,488	4,161	7,728
7	7,728	2,705	5,023
8	5,023	1,758	3,265
9	3,265	1,143	2,122
		93,878

Profit on Sale of Fixed Assets = 12,000 - 2,122= 9,878

3. Discounted Cash Flows

Year	1	2	3	4	5	6	7	8	9
Cash Flows	$        32,000.00	$         33,600.00	$         35,280.00	$         37,044.00	$        38,896.00	$        40,841.00	$         42,883.00	$         45,027.00	$           47,278.00
Profit on Sale of Machine	-	-	-	-	-	-	-	-	$              9,878.00
Interest Cost	$        576.00	$         576.00	$         576.00	$         576.00	$        576.00	$        576.00	$         576.00	$ 403.20	$ 172.80
Depreciation	$ 29,400.00	$      23,310.00	$      15,152.00	$ 9,848.00	$ 6,401.00	$        4,161.00	$ 2,705.00	$ 1,758.00	$           1,143.00
Profit before Tax	$ 2,024.00	$ 9714.00	$      19,552.00	$      26,620.00	$     31,919.00	$     36,104.00	$      39,602.00	$      42,865.80	$        55,840.20
Less: Tax @ 40%	$ 810.00	$ 3886.00	$ 7821.00	$ 10,648.00	$     12,768.00	$     14,442.00	$      15,841.00	$      17,146.00	$        22,336.00
Profit after Tax	$ 1,214.00	$ 5,828.00	$      11,731.00	$      15,972.00	$     19,151.00	$     21,662.00	$      23,761.00	$      25,719.80	$        33,504.20
Add: Depreciation	$ 29,400.00	$   23,310.00	$   15,152.00	$ 9,848.00	$ 6401.00	$     4,161.00	$ 2,705.00	$ 1,758.00	$1,143.00
Less: Profit on Sale of Machine	-	-	-	-	-	-	-	-	$     9,878.00
Less: Repayment of Loan	-	-	-	-	-	-	$     5,760.00	$     7,680.00	$     5,760.00
Add: Salvage Value of Machine	-	-	-	-	-	-	-	-	$        12,000.00
Cash Flows from Project	$ 30,614.00	$ 29,138.00	$   26,883.00	$   25,820.00	$ 25552.00	$ 25,823.00	$   20,706.00	$   19,797.80	$ 31,009.20
Present Value Factor @ 13.06%	0.8845	0.7823	0.6919	0.6120	0.5413	0.4788	0.4235	0.3746	0.3313
Discounted Cash Flows	$ 27,078.00	$   22,795.00	$   18,600.00	$   15,802.00	$ 13,831.00	$ 12,364.00	$ 8,769.00	$ 7,416.00	$ 10,273.00

4. Calculation of NPV

NPV = Total Discounted Cash Flows - Initial Cash Outflows

= $136,928- $ 96,000 = $40,928