Question

Please write answer in your own words because i have to submit on turntin

The CEO of Melbourne Bite (Ronnie) is considering the acquisition of a new project known as Miler Lite. Ronnie need your advice as a chief financial officer (CFO) on the new acquisition using NPV analysis.

A feasibility study has been undertaken at the cost of $750,000 which has indicated that the project is technically feasible. Miler Lite is priced at $15 million, would require $3 million in transportation costs and installation cost of $2 million. Miler Lite has a useful life of 8 years and will be depreciated using straight-line depreciation over the 5-years. It is expected to have a salvage value of $100,000 at the end of 8 years and it would require a $500,000 in net working capital (time zero). Miler Lite would increase revenue by $8.5 million and increase operating cost by $1.5 million a year for the next 8 years. The marginal tax rate is 30 percent and the project’s cost of capital if 20 percent. Would you go ahead with the new acquisition using NPV analysis? Explain.

Answer 1

Solution:

In order to do the feasibility analysis through NPV, we will calculate the NPV and if it positive then we will go ahead with the project.

Cash outflow in year 0  = $750,000 + $15 million+  $3 million+ $2 million = $20,750,000

Value of asset = 15 + 2 + 3 = 20 million and this will be depreciated in 5 years hence depreciation per year = 20 / 5 = 4 million

Tax benefit of depreciation = $4 million * tax rate = $4 million *0.3 = $1.2 million

Revenue = $8.5 million and cost = $1.5 million

Before tax profit = 8.5 - 1.5 = 7 million

After tax profit = 7 million * ( 1-03) = 4.9 million

After tax salvage value = $100,000 * (1-0.7) = $70,000

WC = 500,000 and assuming it will be recovered in year 8 .

Cost of capital = 20%

NPV = 1,273,381.39

The NPV is positive hence we will go ahead with the project