Professional Documents
Culture Documents
1
QUESTION 1 t=0 t=1 t=2 t=3 t=4 t=5
4,50
Taxes 30% $ 4,500.0 $ 19,500 $ 4,500 $ 4,500 $ 4,500 $ 0
-
7,92
Tax on salvage 30% $ 8
317,3
NPV@10% $ 99 -$ 433,000 $107,727 $151,818 $174,576 $144,654 $171,624
(a) Net Operating Cash flows of $200,000 in year 1 are already post the $50,000 promotional
expenditure. I would not have interpreted it that way but I do see how a student could have
interpreted it that way.
(b) The question is whether the company should have ignored the $15,000 p.a. in lost lease revenue
and instead have inserted an initial outflow of $350,000 representing the temporary lost ability to
sell the premises for $350,000. I am sympathetic to that argument ONLY if you believe the company
had this avenue in mind as a FIRST alternative to the use of the factory for processing the new
product. If you believe the company would have simply continued renting the premises out then you
cannot believe a sale was in mind. I draw your attention to the assignment information: This factory
is currently being rented to another company under a lease agreement that has 5 years to run. This
would normally be construed as meaning the company would have simply continued receiving the
$15,000 P.A. (at least for next 5 years)
2
If you could establish the sale of premises theory as a first alternative to processing the new
product (and I do not believe you can), then you have many problems to resolve in the
economics
(c) Accumulated Depreciation (for tax purposes) of the building and its fittings at time zero of new
project. (We will assume the land component of the premises was not depreciable).
(d) Capital gains tax (CGT) on disposal of premises at time zero being 30% tax * ($350,000 selling
price minus selling fees minus cost of land component when procured less tax base of the
depreciable components being building and fittings). Tax base means original cost of the
components less accumulated tax depreciation.
(e) You would then show a "theoretical" outflow being $350,000 less selling fees less CGT
being your lost sales opportunity. Lets call the "theoretical" outflow "x"
(f) You would then have to show the $15000 penalty (offset with a $4500 tax benefit) as an outflow at
time zero as we still need to get the industrial tenant out.
(g) You would then need to show a positive at the end of year 5 which reverses "x" above. This is very
similar in nature to the reversal of the $22,500 net operating working capital. The reason you would
do that is because you are "releasing" resources back to the business. You use the factory for 5
years to do production and then you release it back to the business.
If you were able to imagine the premises would be more valuable than $350,000 at the end of 5 years you
would factor in that knowledge but it would be best to be conservative and ignore as it is a very big
complication
3
QUESTION 2
Required:
(b) What are the incremental cash flows over the projects life in
years 1-4?
4
(e) What is the IRR? You may need an Excel spread-sheet to make
this calculation.
Answer: $47350
(a)
Initial Investment (Time = 0)
New unit ($55,000)
Old unit $15,000 BV(t=0) = $10,000
Less Tax ($2,350)
(b) What are the incremental cash flows over the projects life
in years 1-4?
Answer: $15360
5
Incremental Revenue (New-Old) $0 $0
Answer: $2725
6
1 1 $25,660
NPV $47,350 $15,360 4
0.2 0.2(1.2) 1.25
NPV = $2,725.14
7
QUESTION
A risk-averse male retiree in Australia has some savings to invest with the
objective of generating a stream of stable income to support his spending
needs. Advise him on whether he should invest in government
bonds or company shares. Your advice needs to be supported by two
valid reasons.