Question

The project has a useful life of 10 years. Land costs $5m and is estimated to have a resale value of $7m at the completion of the project. Buildings cost $4m, with allowable depreciation of 5% pa straight-line and a salvage value of $0.8m. Equipment costs $3m, with allowable depreciation of 20% pa straight-line and a salvage value of $0.4m. An investment allowance of 20% of the equipment cost is available. Revenues are expected to be $5m in year one and rise at 10% pa. Cash expenses are estimated at $2m in year one and rise at 5% pa. The new product will be charged $300,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project. An amount of $200,000 has been spent on a feasibility study for the new project. The project is to be partially financed with a loan of $6m to be repaid annually with equal instalments at a rate of 5% pa over 10 years. Except for initial outlays, assume cash flows occur at the end of each year. The tax rate is 30% and is payable in the year in which profit is earned. The after tax required return for the project is 10% pa.

Answer 1

To ascertain the feasibility of the Project, we need to discount the Cashflows of the Project at the after tax required rate of return, i.e. 10.00% p.a. The steps for the same are :

1. Calculation of Depreciation p.a. :-2. Calculation of EMI and Interest on Loan :-3. Calculation of Discounted Cash Inflows of Project before Depreciation, Interest and Tax :-4. Computation of Tax Liability :-5. Calculation of Discounted Cashflows for the Project;-Analysis :-Since Net CAshflow is positive, the project should be accepted.