Question

NPV's for the two projects. (b) Using the Equivalent Annual Annuity (EAA) Approach which project is best? Be sure to present the EAA's for the two projects. Problem 4. A company is considering purchasing some new machinery. Collectively, the acquisition cost would be $3.72 million plus a transportation charge of $94,0000 to get the machinery to the plant. To better engineer the production flow, $450,000 was spent to pay a production consultant. Special electrical service would be required, that and related (required) plant upgrades will be $124,000. Training of the production workers costing $34,000 is also necessary. An increase in inventory of $75,000 is needed, to supply these raw materials our vendor is requiring that we reduce our account payables by $22,000. The now superior widgets that we will be manufacturing will be able to command a premium of $1,470,000 per year but manufacturing costs will increase by $270,000. The machinery has an economic life of 4 years and will be depreciated to zero using the straight line depreciation method. The machinery is expected to be sold at the end for $180,000. The company is taxed at 32% and can raise capital at a cost of 8%. (a) What is the project's initial cash outflow? (b) What is the project's operating cash flow per year? (c) What is the project's terminating cash flow? Problem 5. Using the information in the previous question: (a) What is the project's NPV? (b) Suppose the project is only operated 3 years at which time the machinery is salvaged for $230,000. What would be the project's terminating cash flow? (c) What is the NPV in part (b) above? What's better: operating for 3 or for 4 years?

Answer 1

Initial cash outflow = Acquisition cost+transportation charges+other costs+ change in working capital-cashflow from disposal of assets

=3720000+940000+450000+4000+34000+(75000-22000)-180000 = $5141000

Operating cash flow = Net operating income-Taxes+Depreciation

Since there is no change in revenue per year or other amounts, operating cash flow would be same every year.

	Year 1 (in $)
Project revenues(growth rate)	1470000
Gross profit	1470000
(Cash operating expense)	-53000
(Depreciation)	1232500
Net operating income	184500
(Taxes @32%)	59040
NOPAT	125460
Depreciation	1232500
Operating cash flow	1357960

Depreciation = (3720000+940000+450000 -180000)/4= $1232500

Terminal cash flow:

Proceeds from disposal	180000
Tax Rate	32%
Tax	57600
After tax proceeds	122400
Change in working capital	53000
Terminal cashflow	175400

To calculate NPV, use formula :

NPV= Present value of net cash inflows-initial investment

Present value = Future value/(1+r)^t