Question

Hondai (Ltd) that operate in the automobile inductry is considering replacing a machine with a new one that requires a R4 200 000 investment. the opearting cash inflows over the next 9years will be R740 000 per annum and the cash inflow for the 10th year will be R220 000. Thereafter the machine will be sold for R400 000. The company uses staright-line depreciation. The cost of capital for projects os similar riskis 11%. Note: average profit id R308 000. Ignore taxation. calculate the net present value (NPV) and briefly comment on the viability of the proposed investment. justify why the NPV method is the preffered choice for investment appraisals.

Answer 1

Initial Investment		42,00,000
Company uses straight line depreciation
So every year depreciation comes to 4200000/10 = 420000
Scrap value of machine after 10 year = 400000
Cost of capital is 11%
Now calculation of NPV =
Year	Cashflow	DF@11%	Present value
1	740000	0.900900901	666666.7
2	740000	0.811622433	600600.6
3	740000	0.731191381	541081.6
4	740000	0.658730974	487460.9
5	740000	0.593451328	439154
6	740000	0.534640836	395634.2
7	740000	0.481658411	356427.2
8	740000	0.433926496	321105.6
9	740000	0.390924771	289284.3
10	220000	0.352184479	77480.59
10 - scrap value	400000	0.352184479	140873.8
	Total cashinflow at PV	4315770
Here the Cash out (i.e initial investment) is 4200000
And the cash inflow at present value is 4315770
Hence the NPV is 4315770 - 4200000 = 1315770
NPV=131570
Here NPV is positive by 131570, hence it is viable for the company
to considered the proposed investment as cash inflow at present value
is more the the cash outflow at present value. Propoal should be accepted