THY manufactures car radios. The company is interested in purchasing a machine that costs $750,000. It is expected to reduce the variable costs per unit by $5. The company currently has 5 employees who are each paid $80,000 per year. By purchasing the machine it will reduce the firm’s staff number by two. The Machine will be depreciated straight line to a salvage value of $50,000, at which time it will be sold for $50,000. The tax rate is 35% and depreciation is a fully taxable expense. It is also expected that this will reduce working capital by $100,000. Sales are expected to be 18,000 units per year. The WACC/discount rate is 10% per year. What is the NPV?
Thanks for the help!!
Hi! thanks so much for the sample question and detailed solution, I found them really useful.
I wonder if the cash flow at the end of Year 7 should be negative 50,000 instead of positive 50,000?
If so, NPV figure will be different as well?
Thanks heaps Kat!
Yes that was a simple sign error! Make sure you don’t do that in the exam!! I have changed the answer accordingly
Regards
Vinnie
Hi, just wandering why is it that the working capital increases by $100000 at year 0? I mean what is related to this in terms of cash going into the business? i understand that there is a decrease in working capital at the end of 7 years, but why decreases by $100000? How is the cash of the business affected by this working capital?
Hi just wandering where did the $100000 come from for the increase in working capital at the beginning and the $100000 outflow at the end of 7 years? What cash flow is related to this and why is it included at the start?
Hey!
Working capital ties up cash which must be used on current assets such as inventory, accounts receivable. In other words when working capital increases there is less cash available and in effect we see a cash outflow. This is why we see a cash inflow at time zero and a cash outflow at time 7. Although I am not to sure working capital is tested in accounting 101.
Hope this helps
Vinnie
Thanks a lot
Sorry about the double posting i didnt see my first post when i came to the page initially and thought it had not got through.
Yea was wandering if working capital increases, it means increases in CA, so couldnt that mean that bank might have increased, which meant that it could have been a cash inflow?