Bac221 Business Finance: Cash Flow Assessment Answers

1.                          

“Bull at a Gate Fabrications Pty Ltd” is a manufacturing business based in Sydney. Their company tax rate is 30%. It is considering the replacement of a manually operated machine with a fully automated model. Currently 6 full-time operators are needed to operate the machine. This labour costs the company

$320,000 p.a. in wages, holiday pay and compulsory superannuation payments to the employees’ selected funds. In addition, maintenance costs are $32,000 per year.

The machine was bought 4 years ago for $200,000. The Australian Tax Office schedule includes the asset in the 12 year useful-life category and only allows prime cost depreciation (with no residual) for this type of plant and equipment. The company believed that the machine normally would be taken out of service at the 12-year point.

The current disposal value of the machine presently in use is $50,000. The new model has a purchase price of $570,000. It is estimated that shipping and installation would cost $30,000. Maintenance on the new machine would be $60,000 p.a. but the adoption of that machine would cut the cost of defects from $20,000 to $4,000 per year.  

The new machine is in an 8 year useful life tax category (with no residual). As the machine will undergo heavy use, the company believes the 8 years may be quite accurate.  

The company expects the manufacturing business will close down after 8 years of operation of the new machine and that the machine will have no re-sale value at that point.  

The required rate of return for projects of this risk level is 10%.

Required:  

• Determine the cash flows associated with this replacement project.
  
  
• Compute the NPV and advise if you would recommend the project. Included in your summing-up of the project you should make a comment on the IRR value of the project and why the IRR would have to be more or less than required rate of return

2.

• You are evaluating two different audio systems. Ear Surroundcosts $45,000, has a three-year life and costs $5 000 per year to operate. The Audio-Aura costs $65,000, has a five-year life, and costs $4,000 per year to operate. The relevant discount rate is 8 per cent and corresponds with an 8% before–tax cost of debt, with project totally debt-financed. Ignoring depreciation and taxes compute the AEC for both systems. Which one would be preferred if we assume zero salvage value at the end of life for both systems?

• Now assume that prime cost (reflecting their respective lives) is used for both audio systems for tax depreciation purposes. The relevant tax rate is 30 per cent and tax is paid in the year of income. Assume that salvage value for both systems is $10,000. The relevant discount rate however drops to 5.6 per cent [8% * (1-30%)]. Compute the AEC for both systems. Which is preferred now?

Workings
Particulars	Amount ($)
Labour Cost	320000
Maintaince Cost	32000
Depreciation	16666.67
Total	368666.6667
CFAT for 12th yr	385333.33

 

Workings
Particulars	Amount ($)
Cost	570000
Maintaince	60,000
Installation	30,000
Total cost	660,000
Add: Salvage value	71250
CFAT of 8th year	731,250

Year	0	1	2	3	4	5	6	7	8	9	10	11	12
Rate	10%
Discounting Factor	1	0.909090909	0.826446281	0.751314801	0.683013455	0.620921323	0.56447393	0.513158118	0.46650738	0.424097618	0.385543289	0.350493899	0.318630818
CFAT($)	-50,000	368666.6667	368666.6667	368666.6667	368666.6667	368666.6667	368666.6667	368666.6667	368666.6667	368666.6667	368666.6667	368666.6667	385333.33
PV of CFAT($)	-50000	335151.5152	304683.1956	276984.7233	251804.2939	228912.9944	208102.7222	189184.2929	171985.7208	156350.6553	142136.9594	129215.4176	122779.0751
Total CFAT($)														2467291.566
Less- Tax @ 30%														740187.4697
Net CFAT($)														1727104.096
NPV($)	2,467,291.57

Year	0	1	2	3	4	5	6	7	8
Rate	10%
Discounting factor	1	0.909090909	0.826446281	0.751314801	0.683013455	0.620921323	0.56447393	0.513158118	0.46650738
CFAT($)	-660000	660000	660000	660000	660000	660000	660000	660000	731,250
PV of CFAT($)	-660000	600000	545454.5455	495867.7686	450788.8805	409808.0732	372552.7938	338684.358	341133.5218
NPV ($)	2894289.94
IRR	100%

The project is recommended as IRR of the project is greater. IRR have to be greater or less than the required rte of return for decision making of opting the project.

Era Sound
Particulars	Amount ($)
Cost	45000
Cost of operateing	15000
Total cost	60000
ACE of ERA Sound before tax and derpreciation($)	55631.16

 

Audio Ara
Particulars	Amount ($)
Cost	65000
Cost of Operating	4000
Total Cost	69000
ACE of Audio Ara Before tax and depreciation($)	5543.47

Era Sound
Particulars	Amount ($)
Cost	45000
Cost of operateing	15000
Total Cost	60000
Salvage Value	10000
Rate of Discount	5.60%
the present value of the tax shields from depreciation will be	-1.761684643
the present value of the costs which must be recovered	10001.76
ACE($)	-1.76
Comment:
Audio Ara is preferred.

 

Audio Ara
Particulars	Amount ($)
Cost	65000
Cost of Operating	4000
Total Cost	69000
Salvage Value	10000
Rate of Discount	5.60%
the present value of the tax shields from depreciation will be	584.9449976
the present value of the costs which must be recovered	9415.055002
ACE($)	550.73