In: Finance
The machine is estimated to cost $100,000 which can last for 7 years before it becomes too costly to maintain and can be sold for scrap at $15,000. The project is estimated to bring in additional $30,000 cash inflow and incur $10,000 in additional expenses related to the running the machine in the first year. The company expects there will be an annual sales growth of 5% from year 2 onward. Expenses are also expected to grow by 2% annually from the second year of the operation.
The company plans to fund the purchase of the new machine using a bank loan with an interest rate of 10%.
The given is the below information:
Outlfow: 100,000
Cost of capital: 10%
Revenue : 30,000. Increase of 5% year on year
Cost: 10,000. Increase of 2% year on year
Scrap value end of 7 year is 15,000.
The cash flow is projected as given below
Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
Outflow | (100,000) | |||||||
Sales- 5 % increase from year 2 | 30,000 | 31,500 | 33,075 | 34,729 | 36,465 | 38,288 | 40,203 | |
Expenses- 2 % increase from year 2 | (10,000) | (10,200) | (10,404) | (10,612) | (10,824) | (11,041) | (11,262) | |
Scrap Value | 15,000 | |||||||
Cash flow | (100,000) | 20,000 | 21,300 | 22,671 | 24,117 | 25,641 | 27,248 | 43,941 |
Payback period
Payback period is calculated as given below
Capital Investment | 100,000 |
Cumulative Cash flow till year 4 | 88,088 |
Remaining Cost to be recovered (a) | 11,912 |
Net Cash flow year 2 (b)] | 25,641 |
Payback Period, year 4 (a) / (b) | 0.46 |
Total Cash Payback period in years | 4.46 |
NPV of the project
The cash flows are discounted using the cost of capital. Discounting factor is caculated basis the below formula
Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
Discounting Factor | 1 | =1/(1.1)^1 | =1/(1.1)^2 | =1/(1.1)^3 | =1/(1.1)^4 | =1/(1.1)^5 | =1/(1.1)^6 | =1/(1.1)^7 |
Discounting Factor | 1.00 | 0.91 | 0.83 | 0.75 | 0.68 | 0.62 | 0.56 | 0.51 |
The NPV is calculated as given below
Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
Outflow | (100,000.00) | |||||||
Sales- 5 % increase from year 2 | 30,000.00 | 31,500.00 | 33,075.00 | 34,728.75 | 36,465.19 | 38,288.45 | 40,202.87 | |
Expenses- 2 % increase from year 2 | (10,000.00) | (10,200.00) | (10,404.00) | (10,612.08) | (10,824.32) | (11,040.81) | (11,261.62) | |
Scrap Value | 15,000.00 | |||||||
Cash flow | (100,000.00) | 20,000.00 | 21,300.00 | 22,671.00 | 24,116.67 | 25,640.87 | 27,247.64 | 43,941.25 |
Discounting Factor | 1.00 | 0.91 | 0.83 | 0.75 | 0.68 | 0.62 | 0.56 | 0.51 |
Discounted Cash flow = cash flow x disc factor |
(100,000.00) | 18,181.82 | 17,603.31 | 17,033.06 | 16,472.01 | 15,920.96 | 15,380.58 | 22,548.81 |
Total Discounted Cash flow | 23,140.54 |
The NPV is 23,140.54
IRR of the proejct
IRR is when NPV is 0. This is calculated using trial and error method. Basis that, the IRR shall be as given below
Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
Outflow | (100,000.00) | |||||||
Sales- 5 % increase from year 2 | 30,000.00 | 31,500.00 | 33,075.00 | 34,728.75 | 36,465.19 | 38,288.45 | 40,202.87 | |
Expenses- 2 % increase from year 2 | (10,000.00) | (10,200.00) | (10,404.00) | (10,612.08) | (10,824.32) | (11,040.81) | (11,261.62) | |
Scrap Value | 15,000.00 | |||||||
Cash flow | (100,000.00) | 20,000.00 | 21,300.00 | 22,671.00 | 24,116.67 | 25,640.87 | 27,247.64 | 43,941.25 |
Discounting Factor | 1.00 | 0.86 | 0.74 | 0.64 | 0.55 | 0.48 | 0.41 | 0.35 |
Discounted Cash flow | (100,000.00) | 17,247.96 | 15,841.46 | 14,540.99 | 13,339.78 | 12,231.27 | 11,209.23 | 15,589.31 |
Total Discounted Cash flow | 0.00 |
The IRR is 0 when cost of capital is 15.96% and discounting is done at the same rate.