Project Aspire: This project will require the acquisition of plant and machinery

Question

Project Aspire: This project will require the acquisition of plant and machinery costing $2,250,000 which is payable immediately. This machinery will have a scrap value of $375,000 at the end of the 5 years. There is also $140,000 working capital to be used immediately. This amount has been taken from the company’s retained profits and will be repaid at the end of the project. Cash inflows are expected to be $650,000 in year 1 rising at a rate of 7.5% per annum for years 2 to 5 inclusive. Variable costs in year 1 are expected to be $27,000 per annum and are expected to rise at 6.75% per annum. Capital allowances are available on the plant and machinery as follows: $ Year 1 Year 2 Year 3 Year 4 Year 5 600,000 390,000 345,000 300,000 240,000 This project will expand the current product range and will appeal to existing and potential customers. Corporation tax is paid at a rate of 20% and tax is payable one year in arrears. The weighted average cost of capital is 10% and, unless otherwise stated, cash flows occur at the end of the year to which they relate. Prepare a report to the Directors of AYR Co. which includes the following. 1. A calculation of the Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period for project Aspire . Detailed calculations should be included as an appendix to the report. All cash flows should be rounded to the nearest $.

Explanation / Answer

Step 1) Initial investment

=Purchase price of equipment + WC needs

=2250000+140,000

=2390000$

Step 2) statement showing NPV

IRR is the rate at which NPV is 0

At 15.572% NPV is 0, Hence IRR is 15.572%

Payback period

Statement showing cummulative cash flow

Using interpolation method we get

=512347.415/679718.487

=0.7537 Years

Hence payback period = 3+0.7537 = 3.7537 years

Particulars 1 2 3 4 5 Sales 650000 698750 751156.3 807493 868054.9 Variable cost 27000 28822.5 30768.02 32844.86 35061.89 Depreciation 600000 390000 345000 300000 240000 PBT 23000 279927.5 375388.2 474648.1 592993.1 Tax @ 20% 4600 55985.5 75077.65 94929.62 118598.6 PAT 18400 223942 300310.6 379718.5 474394.4 Add: depreciation 600000 390000 345000 300000 240000 Annaul cash flow 618400 613942 645310.6 679718.5 714394.4 Salvage value 375000 WC release 140000 Total cash flow 618400 613942 645310.6 679718.5 1229394 PVIF @ 10% 0.9091 0.8264 0.7513 0.6830 0.6209 PV 562181.8 507390.1 484831.4 464256.9 763357.2 2782017 Less: initial investment 2390000 NPV 392017.4

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