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Problem 1: Diltz Farms is considering investing in an automated egg-sorting system to increase production for intenational (web-based) sales of Diltz Farms' products. The new system will cost $3,000 including installation. It will be fully depreciated in 5 yrs.(straight- line) to zero and generate $150 after-tax gain at the end of the projected period (year 6). The initial working captital will be $300 and will be $500 in year one and increase each year thereafter by 5 percent. Revenues generated from the egg-sorter are expected to be $900 in year one, and increase by five percent each year. Expenses are ten percent of revenues. Diltz Farms' opportunity cost of capital is 8.5% Using the discounted cash-flow analysis, should Diltz Farms invest in the machinery? What is the NPV of the egg- sorter project? Finance Concept: When making capital investment decisions we must consider the effect of a change in cash flows. The Excel spreadsheet is extremely useful in calculating cash flows allowing us to compare different assets or depreciation methods (what-if analysis). Find the accounting yearly depreciation with the straight line method: Depreciable Basis Cost of the Asset- Salvage Value SL (Straight-Line) Depreciation-(Initial Cost-Salvage Value)umber of years Step 1: Hint: Salvage Value for depreciation -0 in cell E22 . Enter values from the problem in cells E20, E21, and E22. 2. In cell E23 enter: E20-E22 3. In cell E24 enter: -E23/E21 [yearly depreciation] 4. Yearly depreciation should be $3,000/5-$600. 5. Salvage Value for year 6 +150 [from problem Cost of Asset Life of Asset in Years Salvage Value Depreciable Basis Yearly depreciation Step 2: Creating a table to calculate the After-Tax Cash Flows and NPV (in millions): YEAR: 3 0 1 2 4 5 6 Initial Investment Salvage Value Working capital Change in Wk Cap Revenues Expenses Depreciation Pretax profit (35%) Profit after tax CF from operations 0 Cash Flow: CF from capital investments CF from working capital CF from operations 3 Total cash flows Discount factor PV of cash flow Net present value 5 -6 48 Discount rate 50 Completing the spreadsheet is a simple use of Excel mathematical functions. You might want to print the instructions first. mpleting the spreadsheet is a simple use of Excel mathematical functions. You might want to print the instructions first. Cash Flow From Operations 1. In year zero enter the initial investment, the initial wkg capital, and the change in wkg cap (0) 2. In year 1 [cell F30] enter the new wkg cap [500], and calculate the change in wkg cap by subtracting year 0 from year 1. In cell F31 enter: -F30-E30 3. In year two, enter year one's wkg cap*1.05 (G30; -F30* 1.05]. Copy the formula through year 5. Also copy chg in wkg cap formula to years 2-6 4. In year one enter revenues. In year two enter year one* 1.05 [-F32*1.05] and copy to year 5 S. In year one enter expenses from problem; in year two multiply year one by 1.1 and copy across. 6. Enter depreciation in year one from the depreciation table and copy (remember $). 7. Yearly pretax profit is revenues minus expenses and depreciation. [F35=F32-F33-F34] Copy across. 8. Calculate the tax by multiplying pretax profit by the tax rate. (0.35) [F36- F35 35] copy across. 9. Subtract the tax from the pretax profit to get the after tax profit. [F37-F35-F36] copy across. 10. To obtain CF from operations: in year 0: --initial investment-ch wkg cap [wil be a negative number] 11. For years 1-5: add Profit After Tax to Depreciation (F37+F34). Copy across. Year 6 is blank Calculating the NPV 1. Cash Flow from capital investments: enter -E28 in cell E40. 2. Cash Flow from working capital: enter -E31 in cell E41 and copy across to J41. 3. Cash Flow from operations: in cell Febnter-F38 and copy across to J42. In cell K41 enter: --K31+K29. 4. Total cash flows: in cell E43 enter -SUM(E40:E42) and copy across to K43. 5. Discount rate: enter the required return (085) in E48 6. Discount factor: in cell E44 enter: -1/((1+SES48 ) 'o) and copy across. Change the exponent in yrs 1-6. 7. PV of cash flow: in cell E45 enter -E44 E43 and copy across. 8. Net present value: in cell E46 enter SUM(E45:K45) T Some check numbers: Year 6 change in working capital -608 Change from wkg cap (K41)-758 Total cash flows for year 5 (J43)-821 With a required retun of 8.5 %, should Diltz Farms go ahead with the new egg-sorter? What is the NPV of the egg-sorter project? What is the IRR of the project? What is the NPV if the required return is 96 Problem 1: Diltz Farms is considering investing in an automated egg-sorting system to increase production for intenational (web-based) sales of Diltz Farms' products. The new system will cost $3,000 including installation. It will be fully depreciated in 5 yrs.(straight- line) to zero and generate $150 after-tax gain at the end of the projected period (year 6). The initial working captital will be $300 and will be $500 in year one and increase each year thereafter by 5 percent. Revenues generated from the egg-sorter are expected to be $900 in year one, and increase by five percent each year. Expenses are ten percent of revenues. Diltz Farms' opportunity cost of capital is 8.5% Using the discounted cash-flow analysis, should Diltz Farms invest in the machinery? What is the NPV of the egg- sorter project? Finance Concept: When making capital investment decisions we must consider the effect of a change in cash flows. The Excel spreadsheet is extremely useful in calculating cash flows allowing us to compare different assets or depreciation methods (what-if analysis). Find the accounting yearly depreciation with the straight line method: Depreciable Basis Cost of the Asset- Salvage Value SL (Straight-Line) Depreciation-(Initial Cost-Salvage Value)umber of years Step 1: Hint: Salvage Value for depreciation -0 in cell E22 . Enter values from the problem in cells E20, E21, and E22. 2. In cell E23 enter: E20-E22 3. In cell E24 enter: -E23/E21 [yearly depreciation] 4. Yearly depreciation should be $3,000/5-$600. 5. Salvage Value for year 6 +150 [from problem Cost of Asset Life of Asset in Years Salvage Value Depreciable Basis Yearly depreciation Step 2: Creating a table to calculate the After-Tax Cash Flows and NPV (in millions): YEAR: 3 0 1 2 4 5 6 Initial Investment Salvage Value Working capital Change in Wk Cap Revenues Expenses Depreciation Pretax profit (35%) Profit after tax CF from operations 0 Cash Flow: CF from capital investments CF from working capital CF from operations 3 Total cash flows Discount factor PV of cash flow Net present value 5 -6 48 Discount rate 50 Completing the spreadsheet is a simple use of Excel mathematical functions. You might want to print the instructions first. mpleting the spreadsheet is a simple use of Excel mathematical functions. You might want to print the instructions first. Cash Flow From Operations 1. In year zero enter the initial investment, the initial wkg capital, and the change in wkg cap (0) 2. In year 1 [cell F30] enter the new wkg cap [500], and calculate the change in wkg cap by subtracting year 0 from year 1. In cell F31 enter: -F30-E30 3. In year two, enter year one's wkg cap*1.05 (G30; -F30* 1.05]. Copy the formula through year 5. Also copy chg in wkg cap formula to years 2-6 4. In year one enter revenues. In year two enter year one* 1.05 [-F32*1.05] and copy to year 5 S. In year one enter expenses from problem; in year two multiply year one by 1.1 and copy across. 6. Enter depreciation in year one from the depreciation table and copy (remember $). 7. Yearly pretax profit is revenues minus expenses and depreciation. [F35=F32-F33-F34] Copy across. 8. Calculate the tax by multiplying pretax profit by the tax rate. (0.35) [F36- F35 35] copy across. 9. Subtract the tax from the pretax profit to get the after tax profit. [F37-F35-F36] copy across. 10. To obtain CF from operations: in year 0: --initial investment-ch wkg cap [wil be a negative number] 11. For years 1-5: add Profit After Tax to Depreciation (F37+F34). Copy across. Year 6 is blank Calculating the NPV 1. Cash Flow from capital investments: enter -E28 in cell E40. 2. Cash Flow from working capital: enter -E31 in cell E41 and copy across to J41. 3. Cash Flow from operations: in cell Febnter-F38 and copy across to J42. In cell K41 enter: --K31+K29. 4. Total cash flows: in cell E43 enter -SUM(E40:E42) and copy across to K43. 5. Discount rate: enter the required return (085) in E48 6. Discount factor: in cell E44 enter: -1/((1+SES48 ) 'o) and copy across. Change the exponent in yrs 1-6. 7. PV of cash flow: in cell E45 enter -E44 E43 and copy across. 8. Net present value: in cell E46 enter SUM(E45:K45) T Some check numbers: Year 6 change in working capital -608 Change from wkg cap (K41)-758 Total cash flows for year 5 (J43)-821 With a required retun of 8.5 %, should Diltz Farms go ahead with the new egg-sorter? What is the NPV of the egg-sorter project? What is the IRR of the project? What is the NPV if the required return is 96