Question

Question 7: [10 marks] (Start a new page) A computerized machining centre has been proposed for a small tool manufacturing company. If the new system, which costs $50,000 and has a useful life of 3 years, is installed it will generate annual revenue of $100,000 and will require $20,000 in annual labour costs, $12,000 in annual material expenses and another $8000 in annual overhead (power and utility) expenses. Assume that the general rate of inflation is anticipated to average 6% during the next 3 years. Also assume that wages (labour) and overheads will increase by 5% per year, and the cost of material will increase by 4% per year. Assume sales revenue to climb at the general inflation rate. Draw the associated cashflow diagram based on equivalent actual dollars. Show your calculations.

Answer 1

Statement showing calculations :

Particulars	Year 1	Year 2	Year 3
Annual Revenue	$100,000	$106,000	$112,360
Less : Annual Labor Costs	($20,000)	($21,000)	($22,050)
Less : Annual Material Costs	($12,000)	($12,480)	($12,979)
Less : Annual Overhead	($8,000)	($8,400)	($8,820)
Profit before taxes	$60,000	$64,120	$68,511
Discounting @ 6%	0.943	0.890	0.840
Discounted Cash Flow	$56,580	$57,067	$57,549

Total Cash Inflow = $56,580 + $57,067 + $57,549 = $171,196

Initial cash outflow - $100,000

Net Cash Inflow = $171,196 - $100,000 = $71,196

Note - Depreciation has not been considered because it is not an item affecting the cash flow. It is a non-cash item.