Flowton enjoys a steady demand for stainless steel infiltrators used in a number
ID: 2585909 • Letter: F
Question
Flowton enjoys a steady demand for stainless steel infiltrators used in a number of chemical processes. Revenues from the infiltrator division are $50 million a year and production costs are $47.50 million. However, the 10 high-precision stamping machines that are used in the production process are coming to the end of their useful life. Option A is to replace each existing machine with a new one. These machines would cost $800,000 each and not involve any addition operating costs. Option B is to buy 10 centrally controlled stampers. This will cost $1.25 million each, but compare to Option A, this would produce a total saving in operator and material cost of $500,000 a year. The stampers of option B are sturdily built and would last 10 years, compared with an estimated 7-year life for the stamping machine of option A. The discount rate is assumed to be 15% per annum for options A and B.
a) Compute the cash-flow tables for Options A and B.
b) Calculate the Net Present Values (NPV), Payback periods and the Internal Rate of returns (IRR) for these two options. I need step by step to better understand in getting the answers please.
c) Based on your answers in 1b), explain which options would you recommend to Flowton?
2) Using Flowton as a case study, critically discuss to what extent Net Present Value (NPV) is an effective tool in investment appraisal.
Explanation / Answer
1-
cash outflow
8000000
1-
cash outflow
12500000
Year
sales revenue
operating cost
annual net cash flow
Year
sales revenue
operating cost
annual net cash flow
1
50000000
47500000
2500000
1
50000000
47000000
3000000
2
50000000
47500000
2500000
2
50000000
47000000
3000000
3
50000000
47500000
2500000
3
50000000
47000000
3000000
4
50000000
47500000
2500000
4
50000000
47000000
3000000
5
50000000
47500000
2500000
5
50000000
47000000
3000000
6
50000000
47500000
2500000
6
50000000
47000000
3000000
7
50000000
47500000
2500000
7
50000000
47000000
3000000
8
50000000
47000000
3000000
9
50000000
47000000
3000000
10
50000000
47000000
3000000
2-
Year
sales revenue
operating cost
annual net cash flow
Year
annual net cash flow
present value of cash flow =cash flow/(1+r)^n r= 15%
1-
cash outflow
0
-8000000
-8000000
0
-12500000
-12500000
1
2500000
2173913.043
1
3000000
2608695.7
2
2500000
1890359.168
2
3000000
2268431
3
2500000
1643790.581
3
3000000
1972548.7
4
2500000
1429383.114
4
3000000
1715259.7
5
2500000
1242941.838
5
3000000
1491530.2
6
2500000
1080818.99
6
3000000
1296982.8
7
2500000
939842.5998
7
3000000
1127811.1
8
3000000
980705.32
Net present value
sum of present value of cash flow
2401049.335
9
3000000
852787.24
IRR using IRR function in MS excel spreadsheet
irr(-8000000,2500000,2500000,2500000,2500000,2500000,2500000,2500000)
24.52%
10
3000000
741554.12
Payback period in years
initial investment/annual cash flow = 8000000/2500000
3.2
Net present value
sum of present value of cash flow
2556305.9
IRR using IRR function in MS excel spreadsheet
irr(-12500000,3000000,3000000,3000000,3000000,3000000,3000000,3000000,3000000,3000000,3000000)
20.18%
Payback period in years
initial investment/annual cash flow = 12500000/3000000
4.1666667
C-
option A
option B
Final decision
NPV
2401049.335
2556305.878
option B
IRR
24.52%
20.18%
Option A
Payback period
3.2
4.166666667
Option A
2-
NPV is an effective tool in selection of a projection because it measures the net cash flow in present value term and measure the net increase in value. it measures the benefits of a project in present value.
1-
cash outflow
8000000
1-
cash outflow
12500000
Year
sales revenue
operating cost
annual net cash flow
Year
sales revenue
operating cost
annual net cash flow
1
50000000
47500000
2500000
1
50000000
47000000
3000000
2
50000000
47500000
2500000
2
50000000
47000000
3000000
3
50000000
47500000
2500000
3
50000000
47000000
3000000
4
50000000
47500000
2500000
4
50000000
47000000
3000000
5
50000000
47500000
2500000
5
50000000
47000000
3000000
6
50000000
47500000
2500000
6
50000000
47000000
3000000
7
50000000
47500000
2500000
7
50000000
47000000
3000000
8
50000000
47000000
3000000
9
50000000
47000000
3000000
10
50000000
47000000
3000000
2-
Year
sales revenue
operating cost
annual net cash flow
Year
annual net cash flow
present value of cash flow =cash flow/(1+r)^n r= 15%
1-
cash outflow
0
-8000000
-8000000
0
-12500000
-12500000
1
2500000
2173913.043
1
3000000
2608695.7
2
2500000
1890359.168
2
3000000
2268431
3
2500000
1643790.581
3
3000000
1972548.7
4
2500000
1429383.114
4
3000000
1715259.7
5
2500000
1242941.838
5
3000000
1491530.2
6
2500000
1080818.99
6
3000000
1296982.8
7
2500000
939842.5998
7
3000000
1127811.1
8
3000000
980705.32
Net present value
sum of present value of cash flow
2401049.335
9
3000000
852787.24
IRR using IRR function in MS excel spreadsheet
irr(-8000000,2500000,2500000,2500000,2500000,2500000,2500000,2500000)
24.52%
10
3000000
741554.12
Payback period in years
initial investment/annual cash flow = 8000000/2500000
3.2
Net present value
sum of present value of cash flow
2556305.9
IRR using IRR function in MS excel spreadsheet
irr(-12500000,3000000,3000000,3000000,3000000,3000000,3000000,3000000,3000000,3000000,3000000)
20.18%
Payback period in years
initial investment/annual cash flow = 12500000/3000000
4.1666667
C-
option A
option B
Final decision
NPV
2401049.335
2556305.878
option B
IRR
24.52%
20.18%
Option A
Payback period
3.2
4.166666667
Option A
2-
NPV is an effective tool in selection of a projection because it measures the net cash flow in present value term and measure the net increase in value. it measures the benefits of a project in present value.
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