. A proposal to manufacture 5000 t/yr. of a halogenated organic intermediate is
ID: 2771415 • Letter: #
Question
. A proposal to manufacture 5000 t/yr. of a halogenated organic intermediate is set out below:
Estimated total capital cost $1,200,000
Construction time 2 years
Working capital 20% of FCI
Operating cost (exc. depreciation) $40 per ton
Revenue from sales $200 per ton
Plant life 10 years
Salvage value $100,000
Land value $100,000
Income tax rate 50%
Operating cost at reduce capacity is expressed as follows:
-0.5
OC = $40* (Capacity/5000)
Time Market forecast (t/yr)
1982 1500
1983 1600
1984 1700
1985 1900
1986 2500
1987 3400
1988 4700
1989 5100
1990 5300
1991 4700
1992 4000
1993 2000
1994 on 0.
Assuming that the intermediate is storable for a maximum of one year, would you recommend proceeding with the proposal? Justify your answer. Analyze the cash flow position. Take present time to be end of 1981.
Explanation / Answer
Estimated Total Capacity
5000 t/yr
operating cost
$ 40 / ton
Revenue
$ 200/ton
Plant Life
10 years
Salvage Value
$100000
Land Value
$100000
Income Tax Rate
50%
Operating Cost at reduced
capacity
-0.5 OC
oc
$40(Capacity/5000)
Calculation of Cash Flows
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
Forecast Sales in tonnes
1500
1600
1700
1900
2500
3400
4700
5100
5300
4700
Production In tonnes
1500
1600
1700
1900
2500
3400
5000
5000
5000
4700
SP
200
200
200
200
200
200
200
200
200
200
Sales Value
300000
320000
340000
380000
500000
680000
940000
1020000
1040000
940000
Operating Cost
40
40
40
40
40
40
40
40
40
40
Operating Cost
60000
64000
68000
76000
100000
136000
188000
204000
212000
188000
Operating cost at reduced capacity
30000
32000
34000
38000
50000
68000
0
0
0
94000
Total Cash Flows
210000
224000
238000
266000
350000
476000
752000
816000
848000
658000
Tax
105000
112000
119000
133000
175000
238000
376000
408000
414000
329000
Net Cash Flow
105000
112000
119000
133000
175000
238000
376000
408000
414000
329000
Salvage Value
100000
Land Value
100000
Working Capital (20% of FCI)
240000
Net Cash Flow
105000
112000
119000
133000
175000
238000
376000
408000
414000
769000
Total Cash Flows
--14,40,000
105000
112000
119000
133000
175000
238000
376000
408000
414000
769000
Internal Rate of return is calculated in Excel using IRR function = 10%
However the same can be calculated using the below formula
Initial Investment = Cash Flow for Year 1/1 +r + Cash Flow Year 2 /(1+r)^2 +…..+ (Cash Flow Year 10+ Salvage value+Land Value +WC)/1+r^10
The following points should be taken into account for the above table (calculated in EXCEL)
The Desirability of the project can be calculated as
Desirability Ratio = Sum of Discounted Cash Flows / Initial Investment
Sum of Discounted Cash Flows = 105000/1.10+112000/1.1^2 + 119000/1.1^3 + 133000/1.1^4 +175000/1.1^5 +238000/1.1^6 +376000/1.1^7+408000/1.1^8+414000/1.1^9 + 769000/1.1^10
= 95454.55+92561.98+89406.46+90840.79+108661.20+134344.80+192947.50+190335+175576.40+296482.80
= 1,466,611
Initial Cash Flow = 1,200,000 + 1200,000*.2 (for working capital)
= 1,200,000 + 240,000
= 1,440,000
Project Desirability Ratio = 1,466,611/1,440,000 = 1.01848
As the project desirability ratio is above 1, the project is recommended for implementation
Estimated Total Capacity
5000 t/yr
operating cost
$ 40 / ton
Revenue
$ 200/ton
Plant Life
10 years
Salvage Value
$100000
Land Value
$100000
Income Tax Rate
50%
Operating Cost at reduced
capacity
-0.5 OC
oc
$40(Capacity/5000)
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