Question

Based on the following:

• The estimated purchase price for the equipment required to move the operation in-house would be $500,000. Additional net working capital to support production (in the form of cash used in Inventory, AR net of AP) would be needed in the amount of $25,000 per year starting in year 0 and through all 5 years of the project to support production.

• The current spending on this component (i.e. annual spend pool) is $875,000. The estimated cash flow savings of bringing the process in-house is 20% or annual savings of $175,000. This includes the additional labor and overhead costs required.

• Your company has access to a credit line and could borrow the funds at a rate of 6%.

• Finally, the equipment required is anticipated to have a somewhat short useful life, as a new wave of technology is on the horizon. Therefore, it is anticipated that the equipment will be sold after five years for $25,000. (i.e. the terminal value).

Your colleague the Product Manager, is convinced the new capability will allow better control of quality and on-time delivery, and that it will last longer than 5 years. He recommends using a 7 Year Equipment Life (which means a 7-year project and savings life), flat annual savings, 10% discount rate. In other words, assume that the machine will last 2 more years and deliver 2 more years of savings. He also feels the equipment will have an estimated terminal value of $15,000 at the end of its 7-year useful life.

Using the data presented above (and ignoring the extraneous information), for this profit and supply chain improvement project, calculate each of the following (where applicable): Show Calculations

o  Nominal Payback

o  Discounted Payback

o  Net Present Value

o  Internal Rate of Return

Answer 1

Tax rate is not given in the question , so assumed to be 0%.

Further calculation of Payback period as,

Payback Calculation
	Y0	1	2	3	4	5	6	7
Simple Cash Flow	$                                                    5,00,000	$                   2,21,450	$        2,72,450	$        2,37,450	$        2,12,450	$        1,94,650	$        2,19,600	$        2,34,650
Cumulative Simple Payback		$                   2,21,450	$        4,93,900	$        7,31,350	$        9,43,800	$      11,38,450	$      13,58,050	$      15,92,700
	2 years +((500000-493900)/ (237450/365)) days	2 years + 9.38 days
Payback period	2 years 0 months
Discounted Cash Flow	$                                                    5,00,000	$                   2,01,318	$        2,25,165	$        1,78,400	$        1,45,106	$        1,20,862	$        1,23,958	$        1,20,413
Cumulative Discounted Payback		$                   2,01,318	$        4,26,483	$        6,04,883	$        7,49,989	$        8,70,852	$        9,94,810	$      11,15,223
	2 years +((500000-426483)/ (178400/12)) months	2 years + 4.95 months
Payback period	2 years 5 months