Assignment:
1. Fjord is considering the purchase of a new machine costing $94,000. This machine can be expected to save $14,750 at the end of each year for 8 years in reduced labour costs. The company's cost of capital is 9% pa effective, and the machine has an estimated scrap value (at the end of 8 years) of $22,000.
a)Calculate the net present value (ignore the effect of taxes). Give your answer in dollars and cents to the nearest cent.
b)According to the NPV calculated above:
- One would recommend that the machine be purchased
- One would NOT recommend that the machine be purchased
2. A company that analyses projects based on after tax cash flows has invested in a project. The project has caused an increase in the tax payable by the company that has increased by $10,000.
Due to a special ruling by the tax office, the company has been given the choice of paying the $10,000 immediately or in exactly one year.
a)The company should:
- pay the tax now
- pay the tax in exactly one year
b)This is because:
- the time value of money means that the $10,000 paid in one year is worth more than $10,000 paid immediately
- the time value of money means that the $10,000 paid in one year is worth less than $10,000 paid immediately
- the original capital budgeting cash flows assumed tax is payable at the end of each period and those cash flows should be followed as closely as possible
- the original capital budgeting cash flows assumed tax is payable at the beginning of each period and those cash flows should be followed as closely as possible
3. A company that analyses projects based on after tax cash flows is considering investing in a project. Accepting this project will cause an increase in the company's expected level of income tax deductions. This additional tax deduction:
- must be taken into account when analysing the project as a reduction in cash outflows
- only affects cash flows and not accounting profits which means it will not affect the capital budgeting decision
- must be taken into account when analysing the project as a reduction in cash inflows
- only affects accounting profits and not cash flows which means it will not affect the capital budgeting decision
4. IBX Pty Ltd is considering the purchase of a new machine that is expected to save the company $74,000 at the end of each year in reduced wages.
The machine costs $220,000, plus another $14,000 to be installed. It is expected to last for five years after which it can be sold as scrap for $55,000. Operating expenses (such as fuel and maintenance) are $9,000 pa.
a) Determine the annual net cash flows of this investment (ignore the effect of taxes). Enter the information in the following table. Indicate whether cash flows are + or -:
Time 0 1 2 3 4 5
Net Cash Flow
b) Calculate the NPV if the required rate of return is 16% pa. Give your answer in dollars and cents to the nearest cent.
c) Calculate the NPV if the required rate of return is 18% pa. Give your answer in dollars and cents to the nearest cent.