Chapter 7 problem.docx

# Chapter 7 problem.docx - Chapter 7(Problem 1 SatNav system...

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Chapter 7 (Problem) 1. SatNav system plc is considering buying a machine to produce printed circuit board. The machine costs €1.2 million will last for 5 years. The scrap value of the machine is expected to be £200 000. In additional to the capital investment, an investment of £150 000 in working capital will also require. SatNav accounting department has prepare the following estimated annual trading account for the project: (£) Sales 1 400 000 Materials (300 000) Labour (500 000) Depreciation (200 000) Allocated Fixed Overheads (250 000) Annual Profit £150 000 The machine would be financed with a 4-year term loan from HSBC bank at an interest rate of 11.5%. The interest payments attract tax relief. The interest payment attract tax relief. The company believes that 10% would be the minimum after-tax return acceptable from a project with this level of risk and, if that return is achieved, then they will be able to increase dividends to shareholders by £50 000 a year over each of the next 5 years. The corporate tax rate is 25%. Required: Calculate the project’s NPV. In assembling the project’s cash flows the following should be ignored. a) Depreciation – this is a non-cash cost and so is irrelevant to the analysis b) Allocated fixed overheads – on the assumption that these represent no incremental cash flows c) Interest payments (plus their associated tax relief) – financing charges are never included in project cash flows, but instead they are implicitly reflected in the required after-tax rate of return/discount rate, which in this example is 10% d) Dividend payments – these too are part of the financing charges and are neverexplicitly included as part of a project’s cash flows. e) Tax Relief on Depreciation calculation: Cost: £1.2m Scrap: £0.2m Loss in value over 5 years: £1m Annual depreciation: £1m ÷ 5 = £0.2m Annual tax relief: £0.2m x 0.25 = £50,000

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Tax on trading profits/year: Sales £1 400 000 Materials (300 000) Labour (500 000) Taxed profit 600 000 Net trading cash flow Tax at 25% 150,000 Project cash flow (£000s) Year 0: Capital expenditure: (£1,200,000) Working capital expenditure: (£150,000) Total expenditure: (£1,350,000) Years 1 to 5 Trading cash flow: £600,000 Tax on cash flow: (£150,000) Tax relief on depreciation: £50,000 Net after tax cash flow: £500,000 per year. Additional Year 5 cash flows Scrap value: £200,000 Working capital recovery: £150,000 Total: £350,000 NPV calculation - £1,350,000 + (£500,000 x A5 10%) + (£350,000 x 1.10 -5) - £1,350,000 + (£500,000 x 3.7908) + (£350,000 x 0.6209) = +£762,715 NPV
2. Helvestic geosystem AG is a geothermal imaging company, based in Geneva. It is owned by two partner, Henrik Blom and Max Bauer, who each hold 50% of the company’s latest accounts show a balance sheet Value for share capital and reserves of CHF 250 000 ( Swiss Francs) and an annual turnover of CHF 1.25 million. The company has recently been offered two contract, both of which would commence almost immediately and last for 2 years. Neither contract can be delayed. The price offered are CHF 700 000 for contract 1 and CFH 680 000 for contract 2, payable in each case at the contract’s completion. The skilled labour force of Helvestic is
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