Cash Flows in Relation to The Investment Proposal

Question: Cash Flows in Relation to The Investment Proposal. Answer: Harry Hill is considering replacing an old machine with a new one. The cash flows in relation to the investment proposal are presented below: 0 1 2 3 4 5 Savings $80,000 $80,000 $80,000 $80,000 $80,000 Loss of existing sales ($10,000) ($10,000) ($10,000) ($10,000) ($10,000) Depreciation ($54,000) ($54,000) ($54,000) ($54,000) ($54,000) Profit before tax $16,000 $16,000 $16,000 $16,000 $16,000 Tax @ 30% $4,800 $4,800 $4,800 $4,800 $4,800 Profit after tax $11,200 $11,200 $11,200 $11,200 $11,200 cash flow from operations $65,200 $65,200 $65,200 $65,200 $65,200 Initial investment -$2,42,000 Terminal cash flows $70,000 Net cash flow from operations -$2,42,000 $65,200 $65,200 $65,200 $65,200 $1,35,200 Cost of capital @ 10% 1 0.909 0.826 0.751 0.683 0.621 Present value of cash flows -$2,42,000 $59,267 $53,855 $48,965 $44,532 $83,959 Working Notes: Initial Investment Cost of Machine $3,20,000 Increase in working capital $27,000 after tax proceeds from sale of old machine $1,05,000 Initial Investment $2,42,000 After Tax proceeds from old Machine Original cost $2,80,000 annual depreciation $28,000 Current book value $1,40,000 Proceeds from sale $90,000 Loss on sale $50,000 Tax on loss on sale $15,000 Proceeds from sale after tax $1,05,000 Depreciation on new machine Cost of machine $3,20,000 Value after depreciation $50,000 Depreciable amount $2,70,000 Depreciation $54,000 Terminal Cash Flow Sale of machine $40,000 Current book value $50,000 Loss on sale $10,000 Tax on loss $3,000 after tax proceeds from sale $43,000 Return of working capital $27,000 Terminal cash flow $70,000 The NPV of the project = Sum of discounted cash flow initial investment = 290578 242000 = $48578 Since the NPV is positive, hence the company should go ahead with the proposal of purchasing the new machine. A positive NPV means the benefits from the project is more than the cost of the project.