Relevant Cashflow Hbs
Essay by sunilsahoo39 • December 7, 2015 • Case Study • 1,448 Words (6 Pages) • 1,061 Views
Name of the student: Amit Tiwari
PGP Max ID: 81500411
Homework on Relevant Cash Flow Calculations: (20 Points)
Question 1: A Mini-case on Estimation of Cash Flows (8 Points)
A firm is considering replacing an old machine at a cost of $110,000. The new machine will to last five years with zero salvage value. It will generate expected annual cost savings of $30,000. The current machine will last for another 10 years. The discount rate is 10 percent. Assume that tax rate is zero and the present machine is fully depreciated with a zero salvage value.
- Should the firm replace the old machine? Show NPV calculations. (2 Points)
T=0 | T=1 | T=2 | T=3 | T=4 | T=5 | |||
1 | Cash Flow | (110,000) | $ 30,000 | $ 30,000 | $ 30,000 | $ 30,000 | $ 30,000 | |
2 | Discount Rate | 10% | 0.9091 | 0.8264 | 0.7513 | 0.683 | 0.6209 | |
3 | NPV | 3,721 |
We can replace the machine as NPV is positive.
- Assume that existing equipment was bought for $80,000 five years ago and is being depreciated on a straight line over ten years towards a zero book value. It continues to have zero salvage value. Should the firm replace the machine? (No calculations are necessary). Limit your answer to 20 words or less. (2 Points)
As tax rate is zero hence the loss of depreciation (Tax Shield) of old machine and the tax shield due to depreciation on new machine have no effect on the relevant cash inflow related to project. Decision relating to replacement will still be the same as above i.e Firm needs to replace the equipment.
- The firm replaces the old machine with new machine. Two years later, an improved machine becomes available which makes the “existing” machine obsolete with no salvage value. The improved machine will cost $150,000 and last five years. The annual additional cost savings over the previous machine is expected to be $40,000. This machine will be depreciated on a straight line towards a zero book value. Other items remain same. What should firm do? Show calculations. (2 Points)
T=0 | T=1 | T=2 | T=3 | T=4 | T=5 | |||||||||||||||||||||||
1 | Cash Flow | $ (150,000) |
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2 | Discount Rate | @ 10% | $ 36,364 | $ 33,056 | $ 30,052 | $ 27,320 | $ 24,836 | |||||||||||||||||||||
3 | NPV | $ 1,628 |
The New Improved machine is costlier than its older counterparts. Though it gives more annualized return and its NPV is still positive though less as compared to the previous replaced machine but still this acquition of the new equipment is viable.
Name of the student: Amit Tiwari
PGP Max ID: 81500411
- Was a mistake made to buy the machine two years ago? No calculations are needed. Limit your answer to 50 words. (2 Points)
That was not a mistake as before 2 years the replaced machine was one of the new models. And now it has become obsolete because of the improved one.
In the above situation the firm could have waited for a better option after some years as the old machine was not fully incapacitate at the time of replacement.
The company has to incur the cost on the new improved machine.
The firm has suffered losses in terms of irrecoverable capital expenditure in relation to the second machine as it has became obsolete after 2 years of its purchase
Name of the student: Amit Tiwari
PGP Max ID: 81500411
Question 2: A Mini-case on Relevant Cash Flows (6 Points)
A finance manager was presented with an analysis of a new project (see the table below) and noted that there was no mention of the following items:
A. The cash flow projections did not include effect of accounts receivables and payables. The average collection period for receivables and average payment period for payables are expected to be 50 days, and 36 days respectively based on 365 days.
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