Question

What is the feasibility expenditure treatment in cash flow statement? (Expense that used to conduct a study before the product being produce)

example question below

The director of East West Bearings forgot to mention one important expenditure which their company has incurred in relation to the establishment of this new plant. This expenditure has taken place in the form of $55,000, which has been paid in two instalments or $27,500 on account of feasibility reports to Alpha Marketing Company. Feasibility report was used to explore marketability of their new bearings produced from the new plant. Both the instalments of $27,500 duly paid before the installation of the new plant in question. Now, once it has been told to your team, you need to demonstrate how you are going to take this feasibility amount into consideration for calculating Cash flows of the project as well as NPV of the plant?

The initial cost is $3,000,000

the cash in flows year 1 to year 9 is $3,726,000

cash in flow in year 10 is $4,656,000

rate of return 7%

Answer 1

1. To calculate the Cash inflows of the project you need to multiply the cash flows with the discounting factors with rat egiven in the qustion becaus cash are scattered in different period and we can't compare cash flows of different perios with cobverting them and making them equal.

So 3726000 is Annual payments flows from year 1 to 9 and 4656000 is the terminnal value at end of 10th year.

Equation will be =3726000 x cumulative discount factor @ 7% for 9 year + 4656000 x PV factor for 10th year @ 7%.

You can easily find this with calculator. Net cash inflows will be :

3726000 x 6.5152 + 4656000 x 0.5083 = 26642280.

2. NPV is Net present value. You will get NPV after deducting Initial investment from Net Inflows.

So 26642280 - 3000000 = 23642280 is the NPV.

The 55000 in this questio is Sunk cost which is irrelevant because you have incurred wheather you accept the project or not.