Pro-Tecc Coating Co. (Reipsic, OH) considers acquiruing new equipment to be inst

Question

Pro-Tecc Coating Co. (Reipsic, OH) considers acquiruing new equipment to be installed in a recently added galvanizing line to meet rapidly increasing demand for the high quality galvanized steel. Mr. Rahulbhai, VP of Finance of the Pro-Tecc is not pretty sure if the new equipment would be profitable. So, Mr. Rahulbhai asks Mr. Pavan, a senior director of finance department to investigate into this decision problem. Mr. Pavan collects the following information:

*Cost of the equipment is $2,000,000.

*The equipment has an expected six-year life.

*The fixed capital will be depreciated as follows:

Year 1: 30 %, Year 2: 35%, Year 3: 20%, Year 4: 10%, Year 5: 5%, Year 6:0 %

*Incremental sales attributable to the new equipment are $1,200,000 in Year 1. They grow at a 25 percent annual rate for the next two years (i.e., years 2& 3) , and then grow at a 10 percent annual rate for the last three years (i.e., years 4,5, and 6).

*Incremental fixed cash operating expenses are $150,000 for Years 1-3 and $130,000 for Years 4-6.

*Incremental variable cash operting expenses are 45% of sales in Year 1, 40% of sales in Year 2, and 35% in Years 3-6.

*Pro-Tecc's marginal tax rate is 30 %.

*Pro-Tecc will sell the equipment for $150,000 when the project terminates.

*WACC= 12% (discount rate)

Required:

you will have to answer the following questions for Mr. Pavan.

*Calculate the cash flows for each year (Year 0-Year 6). Make sure to fill all cells in yellow and show all your calulations within the cells using the excel formula function.

*Calculate NPV of the equipment.

Explanation / Answer

1.Calculation of cash flows for year o to year 6 :

Working note :

            Initial cash outlay = $2,000,000

           Less:Salvage value=   $150,000

Depreciable amount=$1,850,000                         

Cash flow in year 0 is $2000000

2) Calculation of Npv of proposal :

Net present value of equipement would be $1368500

Assumption :

                          Since it was not given depreciation is straight line method, we can calculate depreciation directly on 2000000 also,but as a sound business analyst we should calculate depreciation after deducting salvage value only because it is not declining balance method.
    

Particulars Y1 Y2 Y3 Y4 Y5 Y6 Sales 1200000 1500000 1875000 2062500 2268750 2495625 Less:Variablecost (540000) (600000) (656250) (721875) (794063) (873469) Gross margin 660000 900000 1218750 1340625 1474687 1622156 Less:fixed costs (150000) (150000) (150000) (130000) (130000) (130000)        Depreciation (555000) (647500) (370000) (185000) (92500) ------ Profit before tax (45000) 102500 698750 1025625 1252187 1492156 Less:Tax@30% Nil 30750 209625 307688 375656 447647 Profit after tax (45000) 71750 489125 717937 876531 1044509 Add:Depreciation 555000 647500 370000 185000 92500 ----- net cash flow 510000 719250 859125 902937 969031 1044509

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