Your organization is looking at 4 transmittals, each costing $450,000: Transmitt
ID: 2631391 • Letter: Y
Question
Your organization is looking at 4 transmittals, each costing $450,000: Transmittal A is estimated to generate net benefits of $125,000 per year for 5 years; Transmittal B is estimated to generate operating income of $100,000 for 6 years plus save an additional $10,000 per year; Transmittal C is estimated to save $75,000 per year for 10 years but requires additional corporate overhead of $10,000 per year. Transmittal D will increase revenue by $60,000 for 10 years, plus save $25,000 per year of operating expenses for the 1st 5 years only. Please show how you arrived at answer.
Explanation / Answer
Discounting rate Acquittal A Acquittal B Acquittal C Acquittal D Year 8 Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow 0 1.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 1 0.93 125000.00 115740.74 110000.00 101851.85 65000.00 60185.19 85000.00 78703.70 2 0.86 125000.00 107167.35 110000.00 94307.27 65000.00 55727.02 85000.00 72873.80 3 0.79 125000.00 99229.03 110000.00 87321.55 65000.00 51599.10 85000.00 67475.74 4 0.74 125000.00 91878.73 110000.00 80853.28 65000.00 47776.94 85000.00 62477.54 5 0.68 125000.00 85072.90 110000.00 74864.15 65000.00 44237.91 85000.00 57849.57 6 0.63 110000.00 69318.66 65000.00 40961.03 60000.00 37810.18 7 0.58 65000.00 37926.88 60000.00 35009.42 8 0.54 65000.00 35117.48 60000.00 32416.13 9 0.50 65000.00 32516.18 60000.00 30014.94 10 0.46 65000.00 30107.58 60000.00 27791.61 NPV 49088.75 58516.76 -13844.71 52422.63 Answer to 1) Acquittal A,B and D will be chosen Answer to 2) If the cost of capital changes to 10% the discounting rate is changed as calculated below. Discounting rate Acquittal A Acquittal B Acquittal C Acquittal D Year 10 Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow 0 1.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 1 0.91 125000.00 113636.36 110000.00 100000.00 65000.00 59090.91 85000.00 77272.73 2 0.83 125000.00 103305.79 110000.00 90909.09 65000.00 53719.01 85000.00 70247.93 3 0.75 125000.00 93914.35 110000.00 82644.63 65000.00 48835.46 85000.00 63861.76 4 0.68 125000.00 85376.68 110000.00 75131.48 65000.00 44395.87 85000.00 58056.14 5 0.62 125000.00 77615.17 110000.00 68301.35 65000.00 40359.89 85000.00 52778.31 6 0.56 110000.00 62092.13 65000.00 36690.81 60000.00 33868.44 7 0.51 65000.00 33355.28 60000.00 30789.49 8 0.47 65000.00 30322.98 60000.00 27990.44 9 0.42 65000.00 27566.35 60000.00 25445.86 10 0.39 65000.00 25060.31 60000.00 23132.60 NPV 23848.35 29078.68 -50603.14 13443.70 Answer to 3) Yes the cash flows will then be taken as post tax as calculated below 0.7 Discounting rate Acquittal A Acquittal B Acquittal C Acquittal D Year 8 Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow 0 1.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 1 0.93 87500.00 81018.52 77000.00 71296.30 45500.00 42129.63 59500.00 55092.59 2 0.86 87500.00 75017.15 77000.00 66015.09 45500.00 39008.92 59500.00 51011.66 3 0.79 87500.00 69460.32 77000.00 61125.08 45500.00 36119.37 59500.00 47233.02 4 0.74 87500.00 64315.11 77000.00 56597.30 45500.00 33443.86 59500.00 43734.28 5 0.68 87500.00 59551.03 77000.00 52404.91 45500.00 30966.54 59500.00 40494.70 6 0.63 77000.00 48523.06 45500.00 28672.72 42000.00 26467.12 7 0.58 45500.00 26548.81 42000.00 24506.60 8 0.54 45500.00 24582.23 42000.00 22691.29 9 0.50 45500.00 22761.33 42000.00 21010.46 10 0.46 45500.00 21075.30 42000.00 19454.13 NPV -100637.87 -94038.27 -144691.30 -98304.16 Answer to 4) we will choose a project with NPV 0 as the IRR may be greater than cost of capital. this means that atleast we are not loosing the time value of money that is generated every year. Discounting rate Acquittal A Acquittal B Acquittal C Acquittal D Year 10 Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow Cash flow Dsic. Cash flow 0 1.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 -450000.00 1 0.91 125000.00 113636.36 110000.00 100000.00 65000.00 59090.91 85000.00 77272.73 2 0.83 125000.00 103305.79 110000.00 90909.09 65000.00 53719.01 85000.00 70247.93 3 0.75 125000.00 93914.35 110000.00 82644.63 65000.00 48835.46 85000.00 63861.76 4 0.68 125000.00 85376.68 110000.00 75131.48 65000.00 44395.87 85000.00 58056.14 5 0.62 125000.00 77615.17 110000.00 68301.35 65000.00 40359.89 85000.00 52778.31 6 0.56 110000.00 62092.13 65000.00 36690.81 60000.00 33868.44 7 0.51 65000.00 33355.28 60000.00 30789.49 8 0.47 65000.00 30322.98 60000.00 27990.44 9 0.42 65000.00 27566.35 60000.00 25445.86 10 0.39 65000.00 25060.31 60000.00 23132.60 NPV 23848.35 29078.68 -50603.14 13443.70 IRR 12.05% 12.18% 7.31% 10.75%
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