Question

The XY Company is a soft drink company. Until today, the company bought empty cans from an outside supplier that charges Dew $0.20 per can. In addition, the transportation cost from the outside supplier to the factory is $1,000 per truck that transports 10,000 cans ($0.10 per can). The Dew Company’s management is considering whether to start manufacturing cans in its plant. The cost of a can machine is $1,000,000 and its life span is 6 years. Historically, Dew Company used straight-line depreciation to zero for all of its equipment. This time they will depreciate $100,000 of the machine’s value every year and the book value at the end of year 6 would be 400,000. The company expects the equipment to be actually sold for $350,000 after 6 years. Maintenance and repair costs for the machine will be $50,000 per year. The additional space for the operation will cost the company $100,000 annually. The cost of producing a can in the factory will be $0.17. The cost of capital for Dew is 12% and the corporate tax rate is 40%. Also, assume that the Dew Company sells 4,000,000 soft drinks annually.

1. Calculate the capital cost

2. Calculate the initial outlay, annual operating cash flow and terminal cash flows. Complete the table with the timeline and calculate the NPV and IRR of the project.

Data Section
Old cost per can (outside supplier)
New cost per can (in-house)
Transportation Cost (per can)
Machine Cost
Machine Useful Life
Annual Depreciation (dollar ammount)
Book Value of Machine (end of year 6)
Sale Price of Machine (Actual Salvage-year 6)
Maintenance and Repairs
Additional Space Cost
Number of Cans Sold
Cost of Capital
Tax Rate

Answer 1

Q. 1. Calculate the capital cost
Capital cost is the one-time setup cost of a plant or project. Which is in this case is the cost of a can machine is $1,000,000.
Data Section
Old cost per can (outside supplier)	$0.20
New cost per can (in-house)	$0.17
Transportation Cost (per can)	$0.10
Machine Cost	$1,000,000
Machine Useful Life	6
Annual Depreciation (dollar amount)	$100,000
Book Value of Machine (end of year 6)	$400,000
Sale Price of Machine (Actual Salvage-year 6)	$350,000
Maintenance and Repairs	$50,000
Additional Space Cost	$100,000
Number of Cans Sold	4,000,000
Cost of Capital	12%
Tax Rate	40%
2. Calculate the initial outlay, annual operating cash flow and terminal cash flows. Complete the table with the timeline and calculate the NPV and IRR of the project.
Calculating Net saving after tax if manufactured
	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
(A) No of Units of can to be produce annually	4,000,000	4,000,000	4,000,000	4,000,000	4,000,000	4,000,000
Old Cost of can:
Buying cost (per can)	$0.20	$0.20	$0.20	$0.20	$0.20	$0.20
Transportation Cost (per can)	$0.10	$0.10	$0.10	$0.10	$0.10	$0.10
(B) Total Cost (per can) if purchased	$0.30	$0.30	$0.30	$0.30	$0.30	$0.30
(C) Cost of manufacturing	$0.17	$0.17	$0.17	$0.17	$0.17	$0.17
(D) Saving (per can) (B-C)	$0.13	$0.13	$0.13	$0.13	$0.13	$0.13
(E) Total Gross Saving on 4000000 cans (A*D)	$520,000	$520,000	$520,000	$520,000	$520,000	$520,000
Additional Costs:
Maintenance and Repairs	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000
Additional Space Cost	$100,000	$100,000	$100,000	$100,000	$100,000	$100,000
Annual Depreciation	$100,000	$100,000	$100,000	$100,000	$100,000	$100,000
(F) Total	$250,000	$250,000	$250,000	$250,000	$250,000	$250,000
(G) Total Net Saving before tax on 4000000 cans (E-F)	$270,000	$270,000	$270,000	$270,000	$270,000	$270,000
(H) Tax @ 40% (G*40%)	$108,000	$108,000	$108,000	$108,000	$108,000	$108,000
(I) Total Net Saving after tax on 4000000 cans (E-F)	$162,000	$162,000	$162,000	$162,000	$162,000	$162,000
Calculating Cash flows
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Initial Outlay (cost of Machine)	($1,000,000)	-	-	-	-	-	-
Total Net Saving after tax on 4000000 cans (E-F)	-	$162,000	$162,000	$162,000	$162,000	$162,000	$162,000
Add depreciation	-	$100,000	$100,000	$100,000	$100,000	$100,000	$100,000
Add Recovery of Salvage value	-	-	-	-	-	-	$350,000
Add Tax benefit on loss on sale of machine (refer note-1)	-	-	-	-	-	-	$20,000
Cash flows	($1,000,000)	$262,000	$262,000	$262,000	$262,000	$262,000	$632,000
Discount factor @ 12%	1.00	0.89	0.80	0.71	0.64	0.57	0.51
Present value of Cash flows	($1,000,000)	$   233,929	$   208,865	$   186,486	$   166,506	$   148,666	$ 320,191
NPV	$264,642
IRR	19.8%
Note 1
Book Value of Machine after 6 year	$400,000
Sale Price	$350,000
Loss on Sale	$50,000
Tax Rate	40%
Tax benefit ($50,000*40%)	$20,000