CASE 1 Original Machine Initial cost 500,000 Annual depreciation = 60,000 Purcha

Question

CASE 1 Original Machine Initial cost 500,000 Annual depreciation = 60,000 Purchased 3 years ago Book Value = 320,000 Salvage today 225,000 Salvage in 7 years 80,000 New Machine Initial cost = 1,000,000 10-year life Salvage in 10 years = 120,000 Cost savings 350,000 per year Working capital benefit $100,000 reduction in inventory 5-year MACRS depreciation Required return = 12% Average Tax rate = 43% 5 Year MACRS Table Year Rate 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 4 Create a 10 year pro forma considering the financial situation before the acquisition Create a 10 year pro forma after the acquisition Detail the Operating Cash Flow by year after the Acquisition Calculate the NPV, IRR, Payback and Discounted Payback

Explanation / Answer

A. For Case 1:

B. For Case 2:

Note: Since MARCS table is given, DepreciationT=n = Original Cost * MARCS RateT=n

C: Operating Cash Flows after Aquisition:

(Note: The net cash flows form sale of old asset on purchase of new asset is an investing activity and therefore not considered in Operating cash flow calculations. Also, the Working capital changes is not given to be a per annum savings, thus, considered as one time inventory reduction at initiation of the project.)

D: NPV, IRR, Payback and Discounted Payback Calculations

PVF is calculated by using following formula PVF for year n = 1/(1+Required Rate of Return)n )

NPV = Total of PVs calculated above = $684,160

IRR = 33.28%, calculated as below:

Step 1: calculate NPW using two discount rates (I have taken 15% and 35%):

Year

Cash Flows

PVF @15%

PV

Year

Cash Flows

PVF @35%

PV

0

(871,750)

        1.0000

(871,750)

0

(871,750)

        1.0000

(871,750)

1

385,500

        0.8696

335,217

1

385,500

        0.7407

285,556

2

337,100

        0.7561

254,896

2

337,100

        0.5487

184,966

3

282,060

        0.6575

185,459

3

282,060

        0.4064

114,641

4

249,036

        0.5718

142,387

4

249,036

        0.3011

74,977

5

249,036

        0.4972

123,815

5

249,036

        0.2230

55,538

6

224,268

        0.4323

96,957

6

224,268

        0.1652

37,048

7

199,500

        0.3759

74,999

7

199,500

        0.1224

24,412

8

199,500

        0.3269

65,217

8

199,500

        0.0906

18,083

9

199,500

        0.2843

56,710

9

199,500

        0.0671

13,395

10

267,900

        0.2472

66,221

10

267,900

        0.0497

13,324

NPV =

530,129

NPV =

(49,810)

Step 2: Calculate IRR using following formula:

IRR = Rate 1 + [ (NPV at Rate 1 x (rate 2 - rate 1) ) / (NPV at rate 1 - NPV at rate 2)]

= 0.15+[(530129*(.35-.15))/(530129 - (-49810))]

= 33.28%

Payback and Discounted Payback Period:

Following formulas are used for calulations:

Payback Period = A +(B/C), where:

Discounted Payback Period = A +(B/C), where:

Step 1: Prepare the cumulative cash flow table:

Step 2: Calculate Payback period/ Discounted Payback period using the above formula:

Payback period = 2+ (149150/282060) = 2.53 years

Discounted Payback period = 3 + (58055/158267) = 3.37 years

Year                   1                 2                 3                 4                 5                 6                 7                 8                 9               10 Opening WDV    320,000    260,000    200,000    140,000      80,000      20,000                -                  -                  -                  -   Depreciation        60,000      60,000      60,000      60,000      60,000      20,000                -                  -                  -                  -   Closing WDV    260,000    200,000    140,000      80,000      20,000                -                  -                  -                  -                  -   Salvage Value/ Profit on sale NA NA NA NA NA NA      80,000 NA NA NA

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