ABC enterprise is a large manufacturing firm. It plans to invest $11350000 in 20
ID: 2730566 • Letter: A
Question
ABC enterprise is a large manufacturing firm. It plans to invest $11350000 in 2016 in a new equipment to serve a new community not served previously. The equipment will be depreciated using the straight-line method over seven years, and its salvage value at the end of 7 years is expected to be $1400000. The firm’s industrial engineers and market analysists come to the following conclusion. The project is forecast to generate sales of 2000000 units in year 2017, 4000000 units in year 2018, 5600000 units in year 2019, 6800000 units in year 2020, 7400000 units in year 2021, 3700000 units in year 2022 and 1800000 units in year 2023. The Consumer Price Index (CPI) is 214.537 in year 2016 and it is forecasted to be 215.303 in year 2017, 218.056 in year 2018, 224.939 in year 2019, 229.594 in year 2020, 232.957 in year 2021, 236.736 in year 2022 and 237.017 in year 2023. The cost of capital is forecast to be a constant rate of 13.22% . The tax rate is forecast to be a constant 35.0%. Sales revenue per unit is forecast to be $9.70 in year 2017 and then grow with inflation. Variable cost per unit is forecast to be $5.90 in year 2017 and then grow with inflation. Cash fixed costs are forecast to be $5,280,000 in year 2017 and then grow with inflation What is the discounted payback period (or break-even point) of the investment based on nominal cash flows? What is the Profitability Index based on nominal cash flows? What is the real NPV? What is the Real IRR?Explanation / Answer
1. Discounted payback period using nominal cash flows
Year
Particulars
Cash flow
Disc factor @ 13.22 %
Dsicounted cash flow
Year*discounted cash flow
2017-1
Cash profit
1,508,000
0.88
1327040
1327040
2018-2
Cash profit
6,448,000
0.78
5029440
10058880
2019-3
Cash profit
10,400,000
0.69
7176000
21528000
2020-4
Cash profit
13,364,000
0.61
8152040
32608160
2021-5
Cash profit
14,846,000
0.54
8016840
40084200
2022-6
Cash profit
5,707,000
0.47
2682290
16093740
2023-7
Cash profit
1,014,000
0.42
425880
2981160
Total
32809530
124681180
Discounted payback period = $124681180/$32809530 = 3.8 years
Calculation of cash flows:
Year
No. of units
Selling price
Variable Cost
Contribution
Fixed Cost
Profit
Tax @35%
CFAT
a
b
c
A*(b-c) = d
E
F=d-e
G
H=f-g
2017
2,000,000
9.7
5.9
7,600,000
5,280,000
2,320,000
812,000
1,508,000
2018
4,000,000
9.7
5.9
15,200,000
5,280,000
9,920,000
3,472,000
6,448,000
2019
5,600,000
9.7
5.9
21,280,000
5,280,000
16,00,000
5,600,000
10,400,000
2020
6,800,000
9.7
5.9
25,840,000
5,280,000
20,560,000
7,196,000
13,364,000
2021
7,400,000
9.7
5.9
28,120,000
5,280,000
22,840,000
7,994,000
14,846,000
2022
3,700,000
9.7
5.9
14,060,000
5,280,000
8,780,000
3,073,000
5,707,000
2023
1,800,000
9.7
5.9
6,840,000
5,280,000
1,560,000
546,000
1,014,000
2. Probability Index = PV of Cash Inflows / PV of cash outflows = $32809530 / $11350000 = 2.89
3. Real NPV
Year
Particulars
Cash flow
Disc factor @ 13.22 %
Dsicounted cash flow
2016
Cash investment
11350000
1
(11350000)
2017
Cash profit
1,508,000
0.88
1327040
2018
Cash profit
6508116.28
0.78
5076330.69
2019
Cash profit
10828799.02
0.69
7471871.32
2020
Cash profit
14196996.80
0.61
8660168.05
2021
Cash profit
16007589.49
0.54
8644098.32
2022
Cash profit
6255200.99
0.47
2939944.465
2023
Cash profit
1100771.77
0.42
462324.14
Total NPV in real terms
23231776.98
Calculation of cash flows:
Year
No. of units
Selling price
Variable Cost
Contribution
Fixed Cost
Profit
Tax @35%
CFAT
a
b
c
A*(b-c) = d
E
F=d-e
G
H=f-g
2017
2,000,000
9.70
5.9
7,600,000
5,280,000
2,320,000
812,000
1,508,000
2018
4,000,000
9.82
5.98
15,360,000
5,347,513.41
10012486.59
3504370.31
6508116.28
2019
5,600,000
10.13
6.17
22,176,000
5,516,309.2
16659690.8
5830891.78
10828799.02
2020
6,800,000
10.34
6.30
27,472,000
5,630,466.46
21841533.54
7644536.74
14196996.80
2021
7,400,000
10.49
6.39
30,340,000
5,712,939.25
24627060.75
8619471.26
16007589.49
2022
3,700,000
10.66
6.49
15,429,000
5,805,613.85
9623386.15
3368185.15
6255200.99
2023
1,800,000
10.67
6.50
7,506,000
5,812,504.97
1693495.03
592723.26
1100771.77
Working notes:
For Sales Revenue (Amount in $)
Year
Nominal Cash Flows
(NCF)
Inflation index
Real Cash Flows = NCF* Inflation index of CY /
Inflation index of PY
2017
9.70
215.303
9.70
2018
9.70
218.056
9.82
2019
9.70
224.939
10.13
2020
9.70
229.594
10.34
2021
9.70
232.957
10.49
2022
9.70
236.736
10.66
2023
9.70
237.017
10.67
For Variable cost (Amount in $)
Year
Nominal Cash Flows
(NCF)
Inflation index
Real Cash Flows = NCF* Inflation index of CY /
Inflation index of PY
2017
5.9
215.303
5.9
2018
5.9
218.056
5.98
2019
5.9
224.939
6.17
2020
5.9
229.594
6.30
2021
5.9
232.957
6.39
2022
5.9
236.736
6.49
2023
5.9
237.017
6.50
For Fixed cost (Amount in $)
Year
Nominal Cash Flows
(NCF)
Inflation index
Real Cash Flows = NCF* Inflation index of CY /
Inflation index of PY
2017
5,280,000
215.303
5,280,000
2018
5,280,000
218.056
5,347,513.41
2019
5,280,000
224.939
5,516,309.2
2020
5,280,000
229.594
5,630,466.46
2021
5,280,000
232.957
5,712,939.25
2022
5,280,000
236.736
5,805,613.85
2023
5,280,000
237.017
5,812,504.97
Year
Particulars
Cash flow
Disc factor @ 13.22 %
Dsicounted cash flow
Year*discounted cash flow
2017-1
Cash profit
1,508,000
0.88
1327040
1327040
2018-2
Cash profit
6,448,000
0.78
5029440
10058880
2019-3
Cash profit
10,400,000
0.69
7176000
21528000
2020-4
Cash profit
13,364,000
0.61
8152040
32608160
2021-5
Cash profit
14,846,000
0.54
8016840
40084200
2022-6
Cash profit
5,707,000
0.47
2682290
16093740
2023-7
Cash profit
1,014,000
0.42
425880
2981160
Total
32809530
124681180