Project 1 Calculations must be done in Excel - You must create your own spreadsheet (do not copy and paste someone else's). This question should be done using Method 1 as outlined in lecture 6 (i.e. Tax Effects, then Cash Flows then NPV). Happy corporation projects their future unit sales for a new headphone. The projected unit sales are as below. 1 2 3 4 Unit sales 75000 89000 120000 96000 5 60000 To produce the headphones, the initial net working capital of $2,000,000 is required and additional net working capital is also required each year, which is 20% of the projected sales increase for the following year. The net working capital will be recovered at the end of a project. In addition, the initial installation cost of the machine for production is $21,000,000. The machine will be depreciated for tax purposes using straight-line depreciation with the useful life of 8 years. Also, costs and unit price are as below. Fixed cost Variable cost Price $3,120,000 per year $285 per unit $415 per unit In five years, the machine can be sold for about 30% of its acquisition cost. The tax rate is 30% and the required rate of return is 15%. Tasks (a) What is the NPV of the project? Explain and defend your processes, answer, and calculations clearly. (b) Assuming that the project can be repeated indefinitely, what is the NPV of the project? Suppose that there is another project with the NPV of $4 million and the NPVo of $6 million. Which project would you choose, assuming that two projects are mutually exclusive and can be repeated indefinitely? Why? Explain and defend your processes, answer, and calculations clearly. Project 2 Calculations must be done in Excel - You must create your own spreadsheet (do not copy and paste someone else's). This question should be done using Method 1 as outlined in lecture 6 (i.e. Tax Effects, then Cash Flows then NPV). As the financial advisor to Have Fun Manufacturing you are evaluating the following new investment in a manufacturing project: - The project has a useful life of 8 years. Tasks Land costs $10m and is estimated to have a resale value of $25m at the completion of the project. Buildings cost $12m, with allowable depreciation of 8% pa reducing balance and a salvage value of $10m. Equipment costs $5m, with allowable depreciation of 15% pa reducing balance and a salvage value of $1m. An investment allowance of 20% of the equipment cost is available. Revenues are expected to be $13m in year one and rise at 5% pa. Cash variable costs are estimated at 40% of revenue. Cash fixed costs are estimated at $3m pa. The firm has spent $2m on research and development for the project. Managerial salaries of $900,000 will be allocated to the project, but these managerial positions will be unaffected by the acceptance of the project. An amount of $200,000 has been spent on a feasibility study for the new project. The project is to be partially financed with a loan of $14m to be repaid annually with equal instalments at a rate of 3% pa over 8 years. Except for initial outlays, assume cash flows occur at the end of each year. The tax rate is 30% and is payable in the year in which profit is earned. The after-tax required return for the project is 12% pa. (a) Calculate the NPV. Is the project acceptable? Why or why not? Explain and defend your processes, answer, and calculations clearly. (b) Conduct a sensitivity analysis showing how sensitive the project is to revenues, fixed costs and to the required rate of return. Explain and defend your processes, answer, and calculations clearly. Method One (Recommended) Example: A machine costs $28,000. The salvage value at the end of three years is $500. Net cash benefits are $16,000, $20,000, $12,000 in years 1,2, and 3. Assume an investment allowance of 20%, a depreciation rate of 40% diminishing value and a taxation rate of 30%. Assume tax is paid in the year that income is earned. The company requires a return of 15% after tax for projects of this type of risk. Will borrow $20,000 at 10% to finance the project. Compute the NPV with taxation. DV depreciation: Year 1: $28,000 x 40% = $11,200 Year 2: ($28,000 - $11,200) x 40% = $6,720 Year 3: ($28,000 - $11,200 - $6,720) x 40% = $4,032 Book value at the end of Year 3 = $6,048 Loss on sale: $500 - $6,048 = ($5,548) =salvage value-Book value at the end Step 1: OB Depreciation CB 28000 11200 16800 2 16800 6720 10080 3 10080 4032 6048 4 6048 2419.2 3628.8 3628.8 1451.52 2177.28 OB:opening balance TAX CB:closing balance Cash Benefits Inv Allow 20% Deprec Loss on Sale Taxable Income Tax @ 30% 0 1 2 3 16,000 20,000 12,000 -5,600 -11,200 -6,720 -4,032 -5,548 -800 13,280 2,420 240 -3,984 -726 Method One (Recommended) Example: TAX A machine costs $28,000. The salvage value at the end of three years is $500. Net cash benefits are $16,000, $20,000, $12,000 in years 1,2, and 3. Assume an investment allowance of 20%, a depreciation rate of 40% diminishing value and a taxation rate of 30%. Assume tax is paid in the year that income is earned. The company requires a return of 15% after tax for projects of this type of risk. Will borrow $20,000 at 10% to finance the project. Compute the NPV with taxation. Cash Benefits Inv Allow 20% Deprec Loss on Sale Taxable Income Tax @ 30% 0 Step 2 (Table 2: Net CFs to get NCFAT) Cash Flows Tax 1 2 3 240 -3,984 -726 16,000 20,000 12,000 500 Cash Benefits Salvage Value Outlay NCFAT -28,000 -28,000 16,240 16,016 11,774 -28,000 14,122 12,110 7,742 5,974 DCF @ 15% NPV Step 3: Compute NPV DCF=discounted cash flow 1 2 3 16,000 20,000 12,000 . -5,600 -11,200 -6,720 -4,032 -5,548 -800 13,280 2,420 240 -3,984 -726 213J