A company is considering the following investment project: Capital outlay $200,0
ID: 2582589 • Letter: A
Question
A company is considering the following investment project:
Capital outlay $200,000
Net Profit p.a. (before depreciation and tax) $ 90,000
Depreciation p.a. $ 40,000
Economic life: 5 years
Salvage value: Zero
Tax rate payable (assume paid in year of income): 30%
Required rate of return: 12% (WACC + Risk factor)
Assessment Task: Calculate the following:
(i) The Net Profit After Tax for each year.
(ii) The Annual Cash Flow for each year.
(iii) Accounting Rate of Return (using total investment).
(iv) Payback Period.
(v) Net Present Value.
(vi) Internal Rate Of Return
Evaluating projects on an Independent Basis (rather than Mutually Exclusive) and using NPV evaluation method would mean:
Choose the individual project with the highest NPV (Net Present Value).
(ii) Choose the individual project with the highest ARR.
(iii) Choose all projects with a positive NPV.
(iv) Choose all projects with an ARR greater than the W.A.C.C.
Explanation / Answer
Solution:
Requirement -- Assessment Task – calculate the following:
(i) The Net Profit After Tax for each year
$$
Net Profit before depreciation and tax
$90,000
Less: Depreciation
($40,000)
Net Profit before tax
$50,000
Less: Tax @ 30%
($15,000)
Net Profit
$35,000
Net Profit after tax for each year is $35,000
(ii) The Annual Cash Flow for each year
Annual Cash Flow means the net cash flow generated by the operation. It means only the items involve cash inflow or outflow is considered.
Depreciation is a non cash item hence it is added back to the Net Profit but the benefit of taxation is available on depreciation.
Annual Cash Flow = Net Profit after tax + Depreciation = $35,000 + $40,000 = $75,000
The Annual Cash Flow for each year = $75,000
(iii) Accounting Rate of Return (using total investment)
Accounting rate of return is a technique of capital budgeting to evaluate the proposed investment. It considers the Net Profit after tax as per Profit and loss. This method does not consider Cash Flow and time value of money.
Hence, Accounting Rate of Return (total investment) = Net Profit after tax / Total Investment Amount x 100
= $35,000 / $200,000 x 100
= 17.5%
(iv) Payback Period
Payback period is the length of time within which initial investment is recovered back to the company.
It is a technique of evaluating investment. It does not consider time value of money.
Payback Period in cash of uniform cash flow = Initial Investment / Uniform Annual Cash Flow as calculated in part (ii)
=$200,000 / 75,000
= 2.67 years
(v) Net Present Value
Net Present Value is the difference of Present Value of all future expected cash flows and Present Value of Initial Investment.
Year
Cash Flow
(A)
PV factor @ 12%
(B)
Present Value of Cash Flow
(A*B)
0
Cash Outflow / Capital Outlay
($200,000)
1.000
-$200,000
1
Annual Cash Flow
$75,000
0.893
$66,964
2
Annual Cash Flow
$75,000
0.797
$59,790
3
Annual Cash Flow
$75,000
0.712
$53,384
4
Annual Cash Flow
$75,000
0.636
$47,664
5
Annual Cash Flow
$75,000
0.567
$42,557
Net Present Value
$70,358
Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you
Pls ask separate question for remaining parts.
$$
Net Profit before depreciation and tax
$90,000
Less: Depreciation
($40,000)
Net Profit before tax
$50,000
Less: Tax @ 30%
($15,000)
Net Profit
$35,000
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.