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Homework answers / question archive / Cherry Flavour Company is considering the purchase of a packaging machine
Cherry Flavour Company is considering the purchase of a packaging machine. The purchase price of the machine is RM80,000, plus an additional RM1,500 to ship and RM25,000 to install. The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method. The machine is expected to generate new sales of RM40,000 per year and is expected to save RM15,000 per year in labour expenses over the next 5-years. However, the production costs will also go up by RM3,000 every year. Upon buying the machine, it requires inventories to increase by RM20,000 and accounts payable increase by RM10,000. The change in Net Operating Working Capital is expected to be fully recovered at year 5. The machine is expected to have a disposal value of RM30,000. Cherry Flavour. Company uses an 8% discount rate for capital budgeting purposes and the firm's income tax rate is 40%. a) Calculate the project initial outlay. b) What is the NPV of the proposed project? c) Should Cherry Flavour Company proceed with the project?
| Year | 0 | 1 | 2 | 3 | 4 | 5 |
| 1.Purchase price(80000+1500+25000) | -106500 | |||||
| 2.Increase in NWC(20000-10000) | -10000 | 10000 | ||||
| 3.ATCFon sale(30000*(1-40%)) | 18000 | |||||
| Incl.sales | 40000 | 40000 | 40000 | 40000 | 40000 | |
| Incl.savings in labor | 15000 | 15000 | 15000 | 15000 | 15000 | |
| Increase in prodn.costs | -3000 | -3000 | -3000 | -3000 | -3000 | |
| Incl.depn.(106500/5) | -21300 | -21300 | -21300 | -21300 | -21300 | |
| Incl.EBIT | 30700 | 30700 | 30700 | 30700 | 30700 | |
| Incl.tax at 40% | -12280 | -12280 | -12280 | -12280 | -12280 | |
| Incl.EAT/NOPAT | 18420 | 18420 | 18420 | 18420 | 18420 | |
| Add Back:Depn. | 21300 | 21300 | 21300 | 21300 | 21300 | |
| 4.Incl.OCF | 39720 | 39720 | 39720 | 39720 | 39720 | |
| 5. INCL.FCFs(1+2+3+4) | -116500 | 39720 | 39720 | 39720 | 39720 | 67720 |
| 6.PV F at 8%(1/1.08^yr.n) | 1 | 0.92593 | 0.85734 | 0.79383 | 0.73503 | 0.68058 |
| 7.PV at 8%(5*6) | -116500 | 36777.78 | 34053.5 | 31531.02 | 29195.39 | 46089.09 |
| 8.NPV at 8%(sum of row 7) | 61146.77 | Ans. B |
| Ans.c. YES. Cherry Flavour Co. can proceed with the project as the NPV of its cash flows is POSITIVE. |
| a. Project's initial outlay-- | |
| Purchase price | -80000 |
| Shipping costs | -1500 |
| Installation costs | -25000 |
| Total M/c cost | -106500 |
| Initial NWC reqd. | |
| Inc.in inventory | -20000 |
| Inc. in a/cs payable | 10000 |
| Total NWC reqd. | -10000 |
| a. Project's initial outlay-- | -116500 |
