Question Four CASH FLOW ANALYSIS (20 MARKS) Right Drive Tyres Ltd has t Drive Ty

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Question Four CASH FLOW ANALYSIS (20 MARKS) Right Drive Tyres Ltd has t Drive Tyres Ltd has just completed a $20,000 feasibility study into automated machines and is now g the replacement of a manually operated machine with a fully automated one. Currently, the considering the replacement o f a nual machine needs three full time operators to operate it, costing the company $150,000 in wages annually Maintenance c osts for the manual machine are S18.000 per year The machine was purchased seven years ago at a cost of $180,000 i cost of 180.000 and at the time was expected to run for a life of ten years before being scrapped. It is being de ng depreciated straight line. However, if Right Drive Tyres were to sell the machine at the current market price today it will get S45000 d machane ovta mate The automated machine will cost $450,000 to purchas with further shipping and installations costs of $40,000. The automated machine costs trom $12.000 per year for the manual machine to $2.000 per year. The new machine will be depreciated straight line over its expected life of seven years,with an expected salvage value of $25000. The manual machine can run for another seven years, but will need an overhaul at the end of the third year at a cost S75,000 that can be expensed for tax purposes at that time: The adoption of an automated machine means that we need to source additional inventories, hence net working capital adjustments of $15.000 more to maintain At $24000 per year, and will reduce the.cost of defects The corporate tax rte is 30% Assume a cost Of capital of, soa for discounting purposes. Required: b) Calculate the NPV and IRR of the project and advise whether the company should replace the manual Calculate the relevant cash flows either on an isolation or incremental basis. (15 marks) machine (5 Marks)

Explanation / Answer

Relevant Cash Flows - Incremental Analysis (7 Years) Manual Machine Automated Machine Incremental costs Initial Cost 490000 -490000 Wages 1050000 0 1050000 Maint 126000 168000 -42000 Cost of defects 84000 14000 70000 Addl.Working   Capital 15000 -15000 Salvage @ end of 7 Yr.s -45000 -25000 -20000 1215000 662000 553000 a.   Year Cash flow (Dividends) PV F @ 10% PV @ 10% 0 x (Suppose,the current Div.) 1 1.25*x 0.9091 0.9091*1.25x 2 1.25^2*x 0.8265 0.8265*1.25^2x 3 1.25^3*x 0.7513 0.7513*1.25^3x 3 (1.25^3*x*1.05)/(0.10-0.05) 0.6830 (0.6830*1.25^3x*1.05)/0.05 Equating the cash discounted cash flows to the current price of the stock, (0.9091*1.25x)+(0.8265*1.25^2x)+(0.7513*1.25^3x)+(0.6830*1.25^3x*1.05)=30 Solving for x, in an online equation solver, x= 5.66482 or 5.66 D(0)= 5.66 Projected Dividend D(1)= 5.66*1.25=7.075 or 7.08 b.      Year Revenue-Costs PV F @ 12% PV @ 12% 1 5 5 0.8929 4.4645 2 5.2500 5.2500 0.7972 4.1853 3 5.5125 5.5125 0.7118 3.9238 4 5.7881 5.7881 0.6355 3.6784 5 6.0775 6.0775 0.5674 3.4484 6 6.3814 6.3814 0.5066 3.2328 6 (6.3814(1.05)*40%)/(0.12-0.05) 38.2884 0.5066 19.3969 Value of the Firm= 42.3301 As the value of the firm $ 42.33 Mn. < 75 Mn. This is not a fair offer.

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