htTSREVIEW EXAMINATIONS 347 Question 6 (16 Marks) Graphic Limited provides you w
ID: 2593317 • Letter: H
Question
htTSREVIEW EXAMINATIONS 347 Question 6 (16 Marks) Graphic Limited provides you with the following data on which to evaluate a proposal submitted to replace an existing computer system. Existing $250,000 7 Years Proposal Initial purchase cost Expected life End of life scrap value When purchased Depreciation rate 20 % on Prime Cost Current trade-in value Positive before tax cash flows per year $350,000 5 Years $10,000$40,000 Two years ago New today $100,000 N/A $75,000 $105,000 Additional Information: (i) Company tax rate is 30% payable at the end of the income year. (ii) Cost ofcapital is 10% after tax. Required: (a) Calculate the Net Present Value of the existing system's future cash lows. (b) Calculate the Net Present Value of the proposal's future cash flows (c) Recommend whether or not to accept the proposal. Provide reasons.Explanation / Answer
(a) Net cashflow = Yearly cashflow + Present value of Scrape value net of tax
=(75000*0.7)* Annunity factor for 5 years @ 10% + 10,000 at the end of year 5 net of tax
= (75000*0.7)* 3.7907 + 10,000 * (0.7) * 0.6209
= 199011+4346
= 2,03,357
NPV = 2,03,357 - Relisable value
= 203357-100000 (150000 could aslo have been taken, 150000 is value of asset after 2 years i.e. (250000- 40%)
= 103357
(b)
Net cashflow = Yearly cashflow + Present value of Scrape value net of tax
=(105000*0.7)* Annunity factor for 5 years @ 10% + 40,000 at the end of year 5 net of tax
= (105000*0.7)* 3.7907 + 40,000 * (0.7) * 0.6209
= 278616+17385
= 296001
NPV = Net cash flow - Intial investment
=296001-250000
=46001
where Intial investment = Purchase price of new machine less realisable value of old machine
= 350000-100000
= 250000
(c) NPV in first option is high , so company should not accept the proposal.
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