QUESTION 1 a). Net Present Value is the discounted net value of a project within specified period of time. Net present value is present cash inflows less present cash out flows. Positive net present value promises increase in value, which indicates greater return than those of rate of return and should be accepted…
0 ? 8,000,000 ?8,800,000 ?9,600,000 ?7,200,000 ?6,000,000 Variable costs ?0 ? 5,500,000 ?6,050,000 ?6,600,000 ?4,950,000 ?4,400,000 Contribution ?0 ?2,500,000 ?2,750,000 ?3,000,000 ?2,250,000 ?1,600,000 Additional Fixed costs ?0 ?1,150,000 ?1,150,000 ?1,150,000 ?1,150,000 ?1,150,000 Annual net cash flow ?0 ?1,350,000 ?1,600,000 ?1,850,000 ?1,100,000 ?450,000 The total working capital to be reclaimed at the end of the period =?1,350,000 (?900,000 + ?450,000) The salvage value = ?425,000 (10% ? ?425,000,000). Total variable per unit (Materials and Labour) = ?55 (?30+?25). Year t Cash inflows Cash outflows Net cash flow (1+r)^-t Net present value Initial Investment (Plant and machinery + working capital 2012 0 0 -?5,150,000 -?5,150,000 1 -?5,150,000 Annual net cash flow and Working capital 2013 1 ?1,350,000 -?450,000 ?900,000 0.892857143 ?803,571 Annual net cash flow 2014 2 1,600,000 ?0 ?1,600,000 0.797193878 ?1,275,510 Annual net cash flow 2015 3 1,850,000 ?0 ?1,850,000 0.711780248 ?1,316,793 Annual net cash flow 2016 4 1,100,000 ? 0 ?1,100,000 0.635518078 ?699,070 Working capital + salvage value + Annual net inflow 2017 5 ?2,225,000 ?0 ?2,225,000 0.567426856 ?1,262,525 Net Present value ?207,470 Payback refers to a period when the business is supposed to recoup its initial investment from the cash it generates. Payback period = investment required? Net annual cash flow. Salvage value of the machinery is cash inflow to the company after five years. Year ended 31/12 2012 2013 2014 2015 2016 2017 Sales ?- ?8,000,000 ?8,800,000 ?9,600,000 ?7,200,000 ?6,000,000 Less Variable cost ?- ?5,500,000 ?6,050,000 ?6,600,000 ?4,950,000 ?4,400,000 Contribution ?- ?2,500,000 ?2,750,000 ?3,000,000 ?2,250,000 ?1,600,000 Less Fixed expenses ?- ?1,150,000 ?1,150,000 ?1,150,000 ?1,150,000 ?1,150,000 Net annual inflow ?- ?1,350,000 ?1,600,000 ?1,850,000 ?1,100,000 ?450,000 Average annual Investment required = Cost of new plant and machinery + Additional working capital - less salvage value = ?4,250,000 + ?1,350,000 - ?425,000 = ?5,175,000 Payback period = Investment required/average net annual cash flow =?5,175,000 ??1,270,000 = 4.07 years Where average net cash flow = (?1,350,000 +?1,600,000 +?1,850,000 +?1,100,000 +?450,000)/5 = ?1,270,000 According to Moles, Parrino and Kidwell (2011 p. 386.), Internal Rate of Return is a discount rate that causes the net present value to be zero and is the minimum rate of return that a project under must yield to be acceptable. Trial and error method is used IRR because it involves salvage values and unequal net annual cash inflows. IRR is computed using two rates, one that gives positive and the other that gives negative net present value. If IRR is less than the required, investment is rejected and vice versa. Discount rate of 13.5% Discount rate of 13.0% year Cash inflows cash outflows Net cash flow (1+r)^-t Net present value (1+r)^-t Net present value Initial Investment (Plant and machinery + working capital 0 0 -5150000 -5150000 1 -5150000 1 -5150000 Annual net cash flow and Working capital 1 1350000 -450000 900000 0.881057269 792951.5419 0.884955752 796460.177 Annual net cash flow 2 1600000 0 1600000 0.776261911 1242019.057 0.783146683 1253034.693 Annual net cash flow 3 1850000 0 1850000 0.683931199 1265272.718 0.693050162 1282142.8 Annual net cash flow 4 1100000 0 1100000 0.602582554 662840.8095 0.613318728 674650.6004 Working capital + salvage value + Annual net inflow 5 ...
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