Criteria for Investment

The total first relevant investment is $ 24,480,000. The cost of designs and prototypes should not be included because it is a sunk cost that cannot be recovered, making it irrelevant for decision making. The increases in net working capital must be included because there will be an incremental cash flow if the choice to introduce the new product line is made. Cash flow from disposal of equipment at the end of the project is $ 2,400,000. Any gain realised from the sale will be taxed at 34% thus reducing the net proceeds.

Question 3

Depreciation cost

$ 24,000,000

Recovery period

5 years

DB Factor

200%

Style

Straight-line

Convention

Half year

Basis

Rate

Depreciation

Book Value

1

$ 24,000,000

20.00%

$ 4,800,000

$ 19,200,000

2

$ 19,200,000

32.00%

$ 7,680,000

$ 11,520,000

3

$ 11,520,000

19.20%

$ 4,608,000

$ 6,912,000

4

$ 6,912,000

11.52%

$ 2,764,800

$ 4,147,200

5

$ 4,147,200

11.52%

$ 2,764,800

$ 1,382,400

6

$ 1,382,400

5.76%

$ 1,382,400

-

Question 4

1

2

3

4

5

Currency

$

$

$

$

$

Sales

(a)

16,500,000

17,490,000

18,539,400

19,651,764

20,830,870

Cost of goods sold

40% (a)

6,600,000

6,996,000

7,415,760

7,860,706

8,332,348

Selling, general & Admin

5% (a)

825,000

874,500

926,970

982,588

1,041,543

Fixed Cost

600,000

600,000

600,000

600,000

600,000

Depreciation

4,800,000

7,680,000

4,608,000

2,764,800

2,764,800

Operating income before tax

3,675,000

1,339,500

4,988,670

7,443,670

8,092,178

Taxation

34%

1,249,500

455,430

1,696,148

2,530,848

2,751,341

Operating income after tax

2,425,500

884,070

3,292,522

4,912,822

5,340,838

Add back: depreciation

4,800,000

7,680,000

4,608,000

2,764,800

2,764,800

After-tax operating cash flow

7,225,500

8,564,070

7,900,522

7,677,622

8,105,638

Question 5

0

1

2

3

4

5

$

$

$

$

$

$

Investment outlay

(24,480,000)

After-tax operating cash flow

7,225,500

8,564,070

7,900,522

7,677,622

8,105,638

After-tax salvage value

2,054,016

Return of net working capital

480,000

Cash flows from new project

(24,480,000)

7,225,500

8,564,070

7,900,522

7,677,622

10,639,654

Less: Cash flow from current desk sales

1,650,000

1,650,000

1,650,000

1,650,000

1,650,000

1,650,000

Incremental cash flow

(26,130,000)

5,575,500

6,914,070

6,250,522

6,027,622

8,989,654

Question 6

0

1

2

3

4

5

$

$

$

$

$

$

Incremental cash flow

(26,130,000)

5,575,500

6,914,070

6,250,522

6,027,622

8,989,654

PV of cash flow

(26,130,000)

5,115,138

5,819,434

4,826,550

4,270,120

5,842,658

NPV using 9%

(256,100)

Question 7

The negative net present value indicates that the new project should be rejected by management. It is because it reduced their value of investments in present day terms.

Depreciation

Accrual concept of accounting requires matching of benefits with costs in the period they are incurred. Depreciation allocates costs of assets that live beyond a year. As the cost of the asset is enormous and its benefits are reaped beyond a year, depreciation helps distribute that cost over the useful life of the asset (Gallo, 2014).

Cash Flow

Cash flow is the actual movement of money within a business. It is the true measure of well-being as profits are distorted by different accounting concepts applied. Cash comes into a business when customers pay for products or services. It is utilised in payment for expenses. Inadequate cash flow has led to the collapse of business due to inability to meet obligations (Brooks, 2015).

Operating Cash Flow

Operating cash flow (OCF) is the money generated from an organization ordinary business operations. It excludes secondary sources of capital which include funds from owners or investments. It is used to measure whether a business can sustain operations and grow. It is derived from deducting expenses from revenue generated (Brooks, 2015).

Net Present Value

Ascertaining the profitability of a project entails using net present value (NPV). NPV puts into consideration the cost of funds. It is obtained by comparing the cash flows from an investment in its entire lifetime with the initial investment. The net cash flows are then put into present day terms through discounting. Projects that have positive NPV are worth to be pursued (Gallo, 2014).

Interaction with Business Decisions

Cash flows are vital to assessing the viability and soundness of entities. They are preferred to business profits as they are used in running daily operations. Verifying if the core business is doing well involves accessing the generation of positive cash flows. OCF are then used in investing in the firm as well as repaying the financing provided by owners of capital.

NPV utilizes cash flows to determine the viability of projects. It is obtained by adding back non-cash charges like depreciation to profits to get the OCF. Once fixed capital investment is deducted from the OCF and changes in work capital ascertained, the free cash flow to the firm (FCFF) is obtained. The FCFF is then discounted using the required rate of capital to get the NPV.

References

Gallo, A. (2014). A Refresher on Net Present Value. Harvard Business Review. Retrieved 12 April 2017, from https://hbr.org/2014/11/a-refresher-on-net-present-value

Brooks, R. (2015). Financial Management: Core Concepts (3rd ed., pp. 121-343). London: Pearson College Division.