Question

As the financial advisor to Beena you are evaluating the following new investment in a project.

• The project has a useful life of 12 years.

• Land costs $6m and is estimated to have a resale value of $10m at the completion of the project.

• Buildings cost $5m, with allowable depreciation of 10% pa reducing balance and a salvage value of $0.9m.

• Equipment costs $4m, with allowable depreciation of 20% pa reducing balance and a salvage value of $0.5m. An investment allowance of 20% of the equipment cost is available.

• Revenues are expected to be $7m in year one and rise at 5% pa.

• Cash expenses are estimated at $3m in year one and rise at 3% pa.

• Except for initial outlays, assume cash flows occur at the end of each year.

• The tax rate is 30% and is payable in the year in which profit is earned.

A) Explain how the depreciation is calculated the right way (with or without the use of the salvage value)

B) Calculate the NPV? Is the project acceptable? Why or why not?

Answer 1

A) Depreciation is Calculated using Declining Balance method and depreciation rate for both Bulding and equipment cost is 16.67% for 12 Years

B) Project NPV is 3.07 and since its positive so accept the Project.

please see the calculations below:

Building Cost Depreciation
Year	Beginning Book Value	Depreciation Percent	Depreciation Amount	Accumulated Depreciation Amount	Ending Book Value
1	3.20	16.67%	0.53	0.53	2.67
2	2.67	16.67%	0.44	0.98	2.22
3	2.22	16.67%	0.37	1.35	1.85
4	1.85	16.67%	0.31	1.66	1.54
5	1.54	16.67%	0.26	1.91	1.29
6	1.29	16.67%	0.21	2.13	1.07
7	1.07	16.67%	0.18	2.31	0.89
8	0.89	16.67%	0.15	2.46	0.74
9	0.74	16.67%	0.12	2.58	0.62
10	0.62	16.67%	0.10	2.68	0.52
11	0.52	3.25%	0.02	2.70	0.50
12	0.50	0.00%	0.00	2.70	0.50
Equipments Cost Depreciation
Year	Beginning Book Value	Depreciation Percent	Depreciation Amount	Accumulated Depreciation Amount	Ending Book Value
1	5	16.60%	0.83	0.83	4.17
2	4.17	16.79%	0.7	1.53	3.47
3	3.47	16.71%	0.58	2.11	2.89
4	2.89	16.61%	0.48	2.59	2.41
5	2.41	16.60%	0.4	2.99	2.01
6	2.01	16.92%	0.34	3.33	1.67
7	1.67	16.77%	0.28	3.61	1.39
8	1.39	16.55%	0.23	3.84	1.16
9	1.16	16.38%	0.19	4.03	0.97
10	0.97	7.22%	0.07	4.1	0.9
11	0.9	0.00%	0	4.1	0.9
12	0.9	0.00%	0	4.1

CALCULATION
	1	2	3	4	5	6	7	8	9	10	11	12
Revenue	7.00	7.35	7.72	8.10	8.51	8.93	9.38	9.85	10.34	10.86	11.40	11.97
VC	3.00	3.09	3.18	3.28	3.38	3.48	3.58	3.69	3.80	3.91	4.03	4.15
Fixed costs	6.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00	0.00
Dep	1.36	1.14	0.95	0.79	0.66	0.55	0.46	0.38	0.31	0.17	0.02	0.00
EBT	-3.36	3.12	3.58	4.04	4.47	4.90	5.34	5.78	6.23	6.77	7.35	7.82
Tax30%		0.93	1.08	1.21	1.34	1.47	1.60	1.73	1.87	2.03	2.21	2.35
After tax (NI)	-3.36	2.18	2.51	2.83	3.13	3.43	3.74	4.05	4.36	4.74	5.15	5.47
Net CF	-3.36	2.18	2.51	2.83	3.13	3.43	3.74	4.05	4.36	4.74	5.15	5.47
Details
Building and Equipments Salvag e Value	1.4
Land resale	10.0
Total	11.4
PV	2.93
Year	Net CF	PV Net Cashflow	Net Balance
0	-15.00	-15.00	-15.00
1	-3.36	-3.00	-18.00
2	2.18	1.74	-16.26
3	2.51	1.79	-14.48
4	2.83	1.80	-12.68
5	3.13	1.78	-10.91
6	3.43	1.74	-9.17
7	3.74	1.69	-7.48
8	4.05	1.63	-5.84
9	4.36	1.57	-4.27
10	4.74	1.53	-2.74
11	5.15	1.48	-1.26
12	5.47	1.40	0.14
			3.07
Discount rate	12.00000%
NPV	3.07
Project accept/ Reject	Accept