assignment 4 corporate finance
Post on 04-Apr-2018
213 Views
Preview:
TRANSCRIPT
-
7/30/2019 Assignment 4 Corporate Finance
1/5
Make Cash Flows
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
Direct Costs 50000 50000 50000 50000 50000 50000 50000 50000
Raw Materials 40000 40000 40000 40000 40000 40000 40000 40000
Total Costs 90000 90000 90000 90000 90000 90000 90000 90000
Tax Deductibility (35%) 31500 31500 31500 31500 31500 31500 31500 31500
Total After Tax Costs 58500 58500 58500 58500 58500 58500 58500 58500
Depreciation 5000 5000 5000 5000 5000 5000 5000 5000
Depreciation Tax Shield 1750 1750 1750 1750 1750 1750 1750 1750
Working Capital Return 0 0 0 0 0 0 0 5000
Total Cash Flow -56750 -56750 -56750 -56750 -56750 -56750 -56750 -51750
Discount Rate 1.20 1.44 1.73 2.07 2.49 2.99 3.58 4.30
Present Value of CF -47291.66 -39409.72 -32841.43 -27367.86 -22806.55 -19005.46 -15837.88 -12035.39
Total Net Present Value -216595.97
-
7/30/2019 Assignment 4 Corporate Finance
2/5
Buy Cash FlowsNow Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
Total Costs 83000 83000 83000 83000 83000 83000 83000 83000
Tax Deductibility (35%) 29050 29050 29050 29050 29050 29050 29050 29050
Total after tax costs 53950 53950 53950 53950 53950 53950 53950 53950
Machinery
Buy New 8000
Sell Old 5000
Book Loss 35000
Tax Saving 12250
Total Machinery CF 9250
Depreciation on New Machinery 2000 2000 2000 2000
Depreciation Tax Shield 700 700 700 700
Excess salary 1000 1000 1000 1000 1000 1000 1000 1000
After Tax cost of salary 650 650 650 650 650 650 650 650
Extra Working Capital
WC returned 5000 12450
WC required 12450
Total Working Capital CF 7450
Total Cash Flow -1800 -53900 -53900 -53900 -53900 -54600 -54600 -54600 -42150
Discount Rate 1.20 1.44 1.73 2.07 2.49 2.99 3.58 4.30
Present Value of Cash Flow -44916.66 -37430.55 -31192.12 -25993.44 -21942.51 -18285.42 -15237.85 -9802.74
Net Present Value of Cash Flow from change in Warehouse Expansion -3807.67
Total NPV -210409.00
-
7/30/2019 Assignment 4 Corporate Finance
3/5
Make Product Cash Flow Explanations
For the Cash Flows and the Net Present Value calculations in the Make product decision
there are 4 major factors that would affect the NPV.
1. Total Costs2. Taxation Rate to calculate Tax deductibility of expenses3. Depreciation4. Working Capital
From the assigned reading it can be clearly understood that the total costs consist of the Direct
Manufacturing Costs and the Raw Materials Cost. This amounts to 90000 every year.
The taxation rate is stated as 35% so after the tax deductibility of expenses we are left with the
after tax expenses as 58500.
To calculate the depreciation tax shield we need to know the yearly depreciation on the machinery
alone. We need not include the building or any other infrastructure, as they would be part of sunk
costs. The yearly depreciation is 5000 as the useful life of the machinery is 8 years and the book
value is given as 40000. After applying the tax rate the tax shield is 1750. Total Cash Flow every
year comes to 56750.
At the end of the project we will need to get the cost of working capital that is 2 weeks of raw
materials and finished products. We do not know the direct cost of the working capital so we will
try to estimate it from the yearly cost of raw materials and finished products. Yearly costs of raw
materials are 40000 and cost of finished products is 90000. Calculating the value of 2 weeks worth
of the same will give us the following
WC of raw materials = 2/52 X 40000
WC of finished product = 2/52 X 90000
Total WC = 2/52 X 130000 = 5000
Using the above information we can find the Net Present Value of the costs of making the product in
house for the next 8 years. We shall discount at a rate of 20% as it is specified as the companys
cutoff rate of return.
We shall arrive at a figure of 216595.97 as the Net Present Value of the cost of the production. The
negative sign indicates that the amount will be an outflow on our part without considering the
margins and the end prices of selling the product.
-
7/30/2019 Assignment 4 Corporate Finance
4/5
Buy Product Cash Flows Explanations
For the Cash Flows and the NPV costing of the in the Buy the production decision is based on
several cash flows.
1. Total Costs2. Excess Salary to be paid3. Change in Working Capital4. Change in Cash Outlay due to early expansion of Warehouse5. Depreciation Tax Shield6. Tax Rate7. New Machinery Costs and Associated Depreciation
The total costs will be reduced to 83000. So calculating the after tax costs of buying we get 53950.
When we buy the production from Amalgamated Components we have to re-assign the chief
operator to a job with an advised salary of 7000 and his current contract states he is to be
compensated 8000 so the extra salary has to be accounted for the project costs and the tax
deductibility has to be done.
We have to maintain a higher inventory/stock than if united metal manufactured so the change in
working capital has to be accounted for so the changes have to be done and reimbursed ant the end
of the project.
The warehouse has to be expanded in the 3rd year rather than in the 4th year we should account for
the change in the net present value due to earlier expenses.
We will need to buy a new machinery costing 8000 that we will have to depreciate in a straight-line
method for 4 yrs.
The book value of the loss in the sale of the machinery should be accounted for and the tax benefitfor the loss should appear on the books. The loss is 35000 so the tax benefit can be calculated as
35% of 35000 that will be 12250.
The Working capital required to maintain an average inventory/stock of 15000 items at the rate of
83 cents per item is 12450.
The difference in the net present value of the warehouse expansion in the 3rd and 4th year has been
calculated as 3807.67
The figure has been calculated by assuming an outflow of 50000 and depreciated over 25 years and
calculating the NPV of the expansion project in the 3rd and the 4th years. Then the NPV in the
current year has been calculated and the difference has been shown in the calculations.
-
7/30/2019 Assignment 4 Corporate Finance
5/5
Arbitration between the Buy or Make decision.
The NPV of both the decisions are almost similar. The difference is slightly above 3% of the entire
NPV. So although both the decisions are equally viable the decision should be based on both the
quality and the companys decision on outsourcing the production.
If the production is outsourced the contract could turn out to be costly in the long run as
Amalgamated Components can dictate the terms of the contract and charge higher prices atrenewal of the contract.
Also if there was a competition between suppliers(Amalgamated Components) then the price could
go down further and hence make the Buy decision much more viable.
top related