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1. NET INITIAL INVESTMENT FOR THE MACHINE
Cost of New Machine $410,000
Working Capital Investment $11,000
Cash from Disposal of Old Machine $(21,000)
Net Initial Investment $400,000
2.
Cost of New Machinery $580,000
Training and Running New Machinery $16,000
Cash from Disposal of Current Equipment $(42,000)
Net Initial Investment $554,000
3. Value of Investment (Interest on Investment) = 0.08 x 360,000 = $28,800
Total Value = $28,800 + $360,000 = $388,800
If not invested at 8% interest rate, the value of the money after one year would be
Total Value = $360,000 + $0 = $360,000 since no interest would be earned, the value of the money would remain the same at $360,000
4. NPV
Source Cash flows PVIF12% PV
Initial Investment 250,000 1 (250,000)
Additional Initial costs 25,000 1 (25,000)
Cash flow for Year1 50,000 0.893 44,643
Cash flow for Year 2 75,000 0.797 59,790
CF for Y3 75,000 0.712 53,384
CF for Y4 75,000 0.636 47,664
CF for Y5 75,000 0.567 42,557
NPV -26,962
Decision – Since the NPV < 0, the project should be rejected as its costs are more than the expected returns.
5. Payback Period = Initial Investment/Cash inflows = $291,000 / 80,000 = 3.6375
Payback period = 3 years 7 months 20 days
6.
Year Cash flows ($) Cumulative CF ($)
Year1 65, 0000 65,000
Year2 65,000 130,000
Year3 65,000 195,000
Year4 65,000 260,000
Year5 65,000 325,000
Payback = 1 + 20,000/65,000 = 1 year 3months 20days
7.
Payback period = 250,000/130,000 = 1 year 11 months
8. Machine 1
Payback period = 389,100/120,000 = 3 years, 3months
Machine 2
Payback period = 310,000/120,000 = 2 years 7months
Decision: Using the payback period investment criteria, Machine 2 would be recommended given that it has a shorter payback period that Machine 1, therefore reduces the risks associated with future cash flows. If the cutoff is 3 years, then payback period method ignores the cash flows after the third year and accepts a project with shorter payback period, Machine 2 in this case.
9). Accrual accounting rate of return = NEBT/ initial investment x 100%
AARR = 34,400/409,000 x 100%
AARR = 8.41%
10). AARR = 46,000/285,000 x 100%
AARR = 16.14%
11. Increase in the Tax rate = $(122,000 – 80,000) = $42,000
New Income = $(122,000 – 100,000) = $22,000
Change in Tax rate = 22,000 / 42,000 x 100% = 52.38%
12. Total CF = $(34,000 + 5*24,000 – 650,000)
Total CF = -$496,00013. Loss on disposal of the old machine = Book value – Disposal Value
=$43,500 – $8,200 = $35,300
14. Tax Saving on Loss Disposal = $[14,250 + 50,000][0.42]
Tax Saving on Loss Disposal = $26,98515. Increase in net income = Net income after depreciation and tax
Net Income = (185,000 – 111,000)(1 – 0.4) = 74,000 x 0.6
Net Income = $44,40016. The CF= CF x tax rate
CF = 150,000 [1-0.4] = $90,00017. Residual value = 195,000 – 115,000 = $80,000
Cash flow from sales = $55,000
Net Cash Value from sales = $(55,000 – 80,000) = -$25,000 (1-0.4)
Net CF = – $10,000
Therefore by disposing the asset, Hopewell Factory incurred a loss of $10,000.18. Total cash flow = 5 X 30,000 = $150,000
CF after tax = CF(1-t) = 150,000(1-0.4)
Cash flow after tax = $90,00019. Total cash flow = 5 X 25,000 = $125,000
CF after tax = CF(1-t) = 125,000(1-0.25)
Cash flow after tax = $93,75020. Nominal rate of return on the investment = rate of return – rate of inflation
Nominal Rate of Return on the Investment = [18 – 12]% = 6%
