PROJECT CASH FLOW ANALYSIS

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Shrieves Casting Company is considering adding a new line to its product mix and the capital budgeting analysis is being conducted. The production line would be set up in usued space in Shrieves’ main plant.

The machinery’s invoice price would be approximately $220,000, another $10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment.

The machinery has an economic life of 4 years and the accelerated depreciation rates are as follows: Year 1: 33%,.Year 2: 45%, Year 3: 15%, Year 4: 7%. The machinery is expected to have a salvage value of $50,000 after 4 years of use.

The new line would generate incremental sales of 1,500 units per year for 4 years at an incremental cost of $100 per unit in the first year, excluding depreciation.

Each unit can be sold for $200 in the first year. The sales price and cost are expected to increase by 5% per year due to

inflation. Further, to handle the new line, the firm’s net working capital would

have to increase by an amount equal to 20% of sales revenues. The firm’s tax rate is 40%, and its overall weighted average cost of

capital is 10%.

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A. What is the machinery’s depreciable cost basis ? What are the annual depreciation expenses ?

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Depreciation Basis: Cost + Shipping + Installation

Basis = Cost ( $220,000) + Shipping ( $10,000) + Installation ( $30,000)

= $260,000

Annual Depreciation Expense

Year % (Inıtıal Basis) =Depreciation

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1234

33%45%15%7%

$260,000$260,000$260,000$260,000

$85.8$117$39$18.2

****

What are the annual depreciation expenses ?

B. Calculate the annual sales revenues and costs.

Annual Sales and Costs ( 5% inflation is assumed )

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Units Quantity

Unit Selling price

Unit Cost

Sales

Costs

Revenue

Year 1 Year 2 Year 3 Year 41500

$200

$100

$300000

$150000

$150000

1500

$210

$105

$315000

$157500

$157500

1500

$220,5

$110,25

$330750

$165375

$165375

1500

$231,52

$115,76

$347280

$173640

$173640

Why is it important to include inflation when estimating revenues and costs ?Nominal r > real r. The cost of capital, r, includes a

premium for inflation.

Nominal CF > real CF. This is because inflation.

If you discount real CF with the higher nominal r, then your NPV estimate would be too low.

Nominal CF should be discounted with nominal r and real CF should be discountes with real r.

It is more realistic to find the nominal CF than it is to reduce the nominal r to a real r. 6

C. Calculate the annual operating cash flows of the investment

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Sales

Cost

Deprec.

EBIT

Taxes(40%)

EBIT(1-T)

+Deprec.

Net Op. CF

Year 1

$300,000

$150,000

$85,800

$64,200

$25,680

$38,520

$85,800

$124,320

Year 2

$315,000

$157,500

$117,000

$40,500

$16,200

$24,300

$117,000

$141,300

Year 3

$330,750

$165,375

$39,000

$126,375

$50,500

$75,825

$39,000

$114,825

Year 4

$347,280

$173,640

$18,200

$155,440

$62,176

$93,264

$18,200

$111,464

D. Estimate the required net working capital for each yearNet Working Capital For Each Year

Year Sales NWC (%20) CF Due To Inv. In NWC

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-300,000315,000330,750347,280

60,00063,00066,15069,4560

• 0• 1• 2• 3• 4

-60,000-3000-3150-3300-69,456

E. Calculate the after-tax salvage cash flow

Salvage Cash Flow

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50,000

0

50,000

20,000

30,000

Salvage Value

Book Value

Gain

Tax on SV(0.4)

Net Terminal Cash Flow

F. Calculating net cash flows and NVP

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Initial Cost

Operational CF

NWC CF

Salvage CF

Net Cash Flow

Year 0

-$300,000

0

-$60,000

0

-$320,000

Year 1

0

$124,320

-$3,000

0

$121,320

Year 2

0

$141,300

-$3,150

0

$138,150

Year 3

0

$114,825

-$3,300

0

$111,525

Year 4

0

$111,464

-$69,456

$30,000

$72,008

NPV = $37,437 > $00 1 2 3 4

-$320,00

0

$121,320

$138,150$111,525$72,008

ANY QUESTION?

THANKS FOR YOUR ATTENTION!

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