2 year project Capital required for P&E = $2500 in Y0 WC = $550 in Y1 and $600 i
ID: 2656789 • Letter: 2
Question
2 year project Capital required for P&E = $2500 in Y0
WC = $550 in Y1 and $600 in Y2. Total not incremental WC & required at beginning of the year
Salvage value of P&E at end of 2 years = $900
Depreciation in each of first 2 years = $1,000 Production is 1,000 units per year. Assume revenue & costs are all incurred at the end of each year
Price = $2 / unit in Y1 and increases at a rate of 20%
Operating costs in Y1 = $400, Y2 = $500
Company owns land on which to build a plant which has a book value of $300. The current market value is $300 but it is expected to rise at an annual rate of 5%. The land will be sold after 2 years. Company originally planned to start the project 2 years ago and spent $50 in planning, but shelved it. T
ax rate = 34% Cost of capital = 15%.
Determine if we should undertake the project.
You want to:
1) Analyze Do Project
2) Analyze Don't Do
3) Analyze incremental cash flow
Explanation / Answer
Year 1 revenue = 1000*2 = $2000
Year 1 revenue = 1000*(2.4) = $2400 (20% increase in price)
Tax on profit on sale of P&E = 900(sale) - 500(Book Value)=400(profit)*(0.34)=$136
Working Capital is total, therefore , for year 2, WC=600-550= $50
$900 salvage value is added to the cash flow.
$300 value of land is an asset and it is not a determinant for the taking up of the project as the company already owns the land and has not bought it for the purpose of the project.
The $50 spent 2 years back would have been taken into account (P&L account) because it has already been shelved.
The initial investment is $2500
PV of future cash flows from the project = $2656.41
Therefore, NPV of the project is $156.41.
The incremental cash flow in year 1 is $1033 (PV=$898.71) and in year 2 it is $2325(PV=$1757.7)
If we don't do the project then we would get $300 in year 0.
If we do it then,
The land will be sold at $330.75 after 2 years, which at year 0 has a value of $250.047. Adding to this the NPV of the project undertaken,i.e, $156.41. Total equals $406.457.
It is better to take up the project than selling off the land because if the project is taken there would be a benfit of $106.457(406.457-300).
Note: Brackets indicate negative number or subtraction.
Year Revenue Operating costs Working Capital Depriciation Profit Before Tax Tax(@34%) Profit After Tax Depreciation Cash Flow PV Factor(@15%) PV of Cash Flow 1 2000 (400) (550) (1000) 50 (17) 33 1000 1033 0.870 898.71 2 2400 (500) (50) (1000) 850 (289+136)=(425) 425 1000 1425+900=2325 0.756 1757.7 TOTAL 2656.41Related Questions
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