Question

Murphy’s Motors is considering a new product line to fulfil a four-year contract. The new product line will require an initial fixed asset investment in a machine of $160,000 with the machine to be depreciated straight-line to zero over its four-year tax life (i.e. fully depreciated with no book value at the end of four years). An initial investment in net working capital (NWC) of $90,000 will also need to be paid, with the assumption that the NWC will be returned to the firm in full at the end of year four. The project is estimated to generate $XXX,XXX [your student ID*] in annual sales. It is estimated that 45,000 units will be produced each year and the cost per unit (excluding depreciation expense) will come to $10. At the end of the four years it is estimated the machine could be removed from the factory and sold for $30,000. The tax rate is 30% and the required rate of return on the project is 8%. * please use your student ID as the sales figure for each year – for example if your student ID was 123456, your annual sales figure would be $123,456. Required: (Please draw up a table to assist with the calculations and formatting of answer. Please show all workings to maximise marks). A. Calculate the total project cash flows for the new product line. (3.5 marks) B. Calculate the Net Present Value (NPV) of the proposed investment. C. Based on the NPV calculated in part B above would you advise Murphy to accept or reject the project and provide a reason why? (1.5 mark) D. Calculate the payback period for this project and advise whether Murphy Should use the payback period as the primary criteria for evaluating projects. (1 mark)

use number 515659

Answer 1

	Murphy's Motor
	Capital Investment Appraisal
	Partticulars	Year 0	Year 1	Year 2	Year 3	Year 4
	Initial Investment
	Machine Cost	(160,000)
	Investment in NWC	(90,000)
a	Total Initial Investment	(250,000)
	Cash flow from Operations
	Annual Sales		515,659	515,659	515,659	515,659
	Cost of Production of 45000 units @$10=		450,000	450,000	450,000	450,000
	Depreciation expense		40,000	40,000	40,000	40,000
	Taxable Income		25,659	25,659	25,659	25,659
	Tax @30%		7,698	7,698	7,698	7,698
b	After Tax Income		17,961	17,961	17,961	17,961
c	Add Back Depreciation		40,000	40,000	40,000	40,000
d	Total Cash flow from Operation=c+d=		57,961	57,961	57,961	57,961
	Terminal Cash flow
	Machine sale value less Tax=30000*(1-30%)=					21,000
	Return of NWC					90,000
e	Total Terminal Cash flow					111,000
f	Total Project Cash flow =a+d+f	(250,000)	57,961	57,961	57,961	168,961	Ans A.
g	PV Factor @8%=	1.0000	0.9259	0.8573	0.7938	0.7350
h	PV of Cash flows =f*g=	(250,000)	53,666	49,690	46,010	124,187
i	NPV=Sum of PV of Cash flows =	23,553	Ans B.
Ans C,	Based on the NPV , Murphy should accept the project , as the NPV is positivem Murphy would get positive return from the project
Ans D.	Payback period of the project is 3.45 Years.
	Murphy should not use the payback period as the criteria here as a large amount if NWC invested is returned at
	the end of the project and that causes the higher payback period . The overall profitability
	of the project is not revealed by Payback period method.