Question

ABC limited is considering implementing a project X (New manufacturing machine). The following data has been provided in respect of the project 1. The cost of the project is Sh. 2 Million 2. The WACC of the company is 12% Page 2 of 2 3. The useful life of the project is 5 years 4. Depreciation method is straight line 5. Salvage value is expected to be Sh. 200,000 6. Incremental quantity produced and sold is 100,000 units 7. Variable cost per unit is Sh. 60 8. Tax rate is 30% 9. Contribution margin is Sh. 40 10. Fixed costs have been estimated at Sh. 500,000 Required: (i) Estimate the net cash flow from the project for years 1, 2, 3, 4 and 5 (ii) Estimate the Net Present Value of the project (iii) Advise the company based on the Net Present Value (NPV)

Answer 1

solution:

a)Depreciation for each year

=(Cost-Salvage value)/life

=Sh(2000,000-200,000)/5

=Sh 360,000

b)Annual Incremental net revenue

=(Incremental units*contribution margin)-fixed costs

=(100,000*Sh 40)- Sh. 500,000

=Sh 3500,000

c)Annual After tax cash inflows

	Amount(sh)
Annual Incremental net revenue	3500,000
less:Annual Depreciation	360,000
EBT	3140,000
Less:tax @30%	942,000
EAT	2198,000
Add:Annual Depreciation	360,000
Annual After tax cash inflows	2,558,000

d)Present value of all cash inflows

=(Annual After tax cash inflows*PVAF@12% for 5 year)+(Salvage value*present value interest factor @12% for 5th year)

=Sh 2,558,000*3.6047762+Sh 200,000*0.56743

=Sh 9,221017.52+Sh 113,486   

=Sh 9,334,503.52

e)Calculation of Net Present Value of the project

Net Present Value=Present value of all cash inflows-Cost of project

=Sh 9,334,503.52-Sh 2000,000

=Sh 7334503.52

Since the NPV of project is positive,hence should implement the project.