Project 1 PolyCorp is considering an investment in new plant of $3 million. The project will be financed with a loan of $2,000,000 which will be repaid over the next five years in equal annual end of year instalments at a rate if 8.5 percent pa. Assume straight-line depreciation over a five-year life, and no taxes. The projects cash flows before loan repayments and interest are shown in the table below. Cost of capital is 14% pa. A salvage value of $200,000 is included in the cash flow for year five. Polycorp paid $200,000 for a feasibility study on the project about a year ago. Year Year One Year Two Year Three Year Four Year Five Cash Inflow 950,000 900,000 850,000 850,000 900,000 You are required to calculate: (a) the amount of the loan repayments (b) repayment schedule showing the annual interest component in the repayments (c) NPV of the project (d) the IRR of the project (e) the annual equivalent (AE or EAV) (f) the payback in years (to one decimal place) (g) the accounting rate of return (gross and net) (h) PI (present value index or profitability index) Is the project acceptable? Why or why not? Your answer should include an explanation of your treatment of the salvage value, the cost of the feasibility study, and the interest and repayments on the loan. Project 2 Polycorp Limited Steel Division is considering a proposal to purchase a new machine to manufacture a new product for a potential three year contract. The new machine will cost $1 million. The machine has an estimated life of three years for accounting and taxation purposes. The contract will not continue beyond three years and the equipment estimated salvage value at the end of three years is $100,000. The tax rate is 30 percent and is payable in the year in which profit is earned. An investment allowance of twenty percent is available. The after tax cost of capital is 13.5% pa. Ignore inflation. Addition net working capital of $60,000 is required immediately to support the project. Assume that this amount is recovered at the end of the three year life of the project. The new product will be charged $52,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs (or cash flows) to manage the project. This is in accordance with the firm s policy of allocating all corporate overhead costs to divisions. Extra marketing and administration cash outflows of $40,000 per year will be incurred by the Steel Division. An amount of $30,000 has been spent on a pilot study and market research for the new product. The projections provided here are based on this work. Projected sales for the new product are 30,000 units at $115 per unit per year. Cash operating expenses are estimated to be 80 percent of sales (excludes marketing and administration, and head office items). Except for initial outlays, assume cash flows occur at the end of each year (unless otherwise stated). Assume prime cost or straight line depreciation for tax purposes. Required (a) Construct a table showing your calculations of net cash flow after tax. (Similar to that demonstrated in the notes and in class) (b) Calculate the NPV. Is the project acceptable? Why or why not? (c) Explain your calculation of relevant net cash flows after tax, justifying your selection of cash flows. Be sure to state clearly any assumptions made.

## This question was asked on Jan 15, 2013.

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