Outline
You are to make a report which addresses the two projects detailed below. The report is to be properly formatted (where necessary this includes: rounding, headings, table appearance, appropriate table and the graph headings, justifications, consistency in formatting, cash flow diagrams, and so forth.) with each problem addressed in a separate section. Consist of supporting computations.
Project 1
PolyCorp is considering an investment in the new plant of $3 million. The project will be financed with a loan of $2,000,000 that will be repaid over the next five years in equal yearly end of year instalments at a rate if 8.5 percent pa. Suppose straight-line depreciation over a five-year life, and no taxes. The projects cash flows before loan repayments and interest are shown in table below. Cost of capital is 14% pa. A salvage value of $200,000 is included in cash flow for year five. Polycorp paid $200,000 for a feasibility study on project about a year ago.
Year Year One Year Two Year Three Year Four Year Five
Cash Inflow 950,000 900,000 850,000 850,000 900,000
You are required to calculate:
(a) The amount of loan repayments
(b) Repayment schedule screening annual interest component in the repayments
(c) NPV of project
(d) The IRR of project
(e) The annual equal (AE or EAV)
(f) The payback in the years (to one decimal place)
(g) The accounting rate of return (gross and net)
(h) PI (present value index or profitability index)
Is the project acceptable? Why or why not? Your answer must consist of an explanation of your treatment of salvage value, the cost of feasibility study, and the interest and repayments on the loan.
Project 2
Polycorp Limited Steel Division is considering a proposal to buy a new machine to manufacture a new product for a potential three year contract. The new machine will cost $1 million. The machine has an estimated life of three years for accounting and taxation reasons. The contract will not continue beyond three years and the equipment estimated salvage value at the ending of three years is $100,000. The tax rate is 30 percent and is payable in year in which profit is earned. An investment payment of twenty percent is accessible. The after tax cost of capital is 13.5% pa. Ignore inflation.
Addition net working capital of $60,000 is required immediately to support project. Suppose that this amount is recovered at the end of the three year life of project.
The new product will be charged $52,000 of allocated head office administration costs each year even though head office will not really acquire any extra costs (or cash flows) to manage the project. This is in accordance with the firm’s policy of allocating all corporate overhead costs to divisions.
Extra marketing and administration cash outflows of $40,000 per year will be acquired by the Steel Division.
An amount of $30,000 has been spent on a pilot study and market research for new product. The projections provided here are based on this work.
Projected sales for the new product are 30,000 units at $115 per unit per year. Cash operating expenses are estimated to be 80 percent of sales (excludes marketing and administration, and head office items).
Except for initial outlays, assume cash flows occur at the end of each year (unless otherwise stated). Assume prime cost or straight line depreciation for tax purposes.
Required
(a) Create a table showing your computations of net cash flow after tax. (Similar to that demonstrated in the notes and in class)
(b) Compute the NPV. Is the project acceptable? Why or why not?
(c) Elucidate your computation of relevant net cash flows after tax, justifying your selection of cash flows. Be sure to state clearly any assumptions made.