A company is considering a temporary expansion of its operations. In real terms,

Question

A company is considering a temporary expansion of its operations. In real terms, it expects to generate $900,000 in each of the next two years while incurring operating costs of $600,000 annually. Equipment (Class 8-20%) worth $480,000 would be required over the two year project and it is expected that the equipment could be sold for its book value at the conclusion of the project. The money needed for the equipment would have to be agreed to provide a loan at a 5% interest rate that would be paid back in two equal installments at the end of years one and two. If the tax rate is 40%, the MARR in real terms is 11%, and the inflation rates in years 1 and 2 are 2% and 3% respectively, determine the annual after tax cash flows and the present equivalent of the expansion. (Note: show the detailed cash flow calculation and do not use capital tax factors) borrowed and a bank has

Explanation / Answer

0 1 2 Year Equipment cost 4,80,000.00 Revenue 9,00,000.00 9,00,000.00 9,00,000.00 Cost 6,00,000.00 6,00,000.00 6,00,000.00 Inflation rates 2% 3% Depreciation rate 20% Depreciation 96000 76800 EBIT 2,04,000.00 2,23,200.00 Interest expense 2,58,146.34 2,58,146.34 PBT -54,146.34 -34,946.34 Tax rate 40% Tax -21,658.54 -13,978.54 Using Pmt formula for entire loan to be repaid in 2 years PAT -32,487.80 -20,967.80 Net cash flow 63,512.20 55,832.20 Adding back depreciation MARR 0.11 13% 14% using inflation rates in each year to calculate the nominal MARR PV of net cash flow 98,809.68 Using present value formula

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