about finance

Nova Tractor Corporation: Higher-Cost Chip Crusher (HCC) Nova Tractor Corporation: Lower-Cost Chip Crusher (LCC)

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 0 Year 1 Year 2 Year 3 Year 4
Purchase Price of HCC -$500,000 Purchase Price of LCC -$400,000
Revenue $487,200 $487,200 $487,200 $487,200 $487,200 $487,200 Revenue $436,800 $436,800 $436,800 $436,800
Annual Operating Cost -$133,000 -$133,000 -$133,000 -$133,000 -$133,000 -$133,000 Annual Operating Cost -$136,500 -$136,500 -$136,500 -$136,500
Working Capital -$58,000 $58,000 Working Capital -$62,400 $62,400
Tax savings from depreciation expense $60,000 $36,000 $21,600 $12,960 $7,776 $4,666 Tax savings from depreciation expense $42,000 $27,300 $17,745 $11,534
After tax sales diverted from other lines -$109,200 -$109,200 -$109,200 -$109,200 -$109,200 -$109,200 After tax sales diverted from other lines -$109,200 -$109,200 -$109,200 -$109,200
Sale of Machine $45,000 Sale of Machine $25,000
Capital Gains -$6,502 Capital Gains $13,921
Redundancy payout avoided $50,000 Redundancy payout avoided $0

Annual after-tax net cash flows -$508,000 $305,000 $281,000 $266,600 $257,960 $252,776 $346,164 Annual after-tax net cash flows -$462,400 $233,100 $218,400 $208,845 $303,955

Company RoR 15% Company RoR 15%
Net Present Value (NPV) $567,808 Net Present Value (NPV) $216,543.66
Profitability Index $2.12 Profitability Index $1.47
Internal Rate of return (IRR) 51.71% Internal Rate of return (IRR) 35.86%
Equivalent Annual Value (EAV) $150,035.74 Equivalent Annual Value (EAV) $75,847.74

Additional workings Additional workings
Company tax rate 30% Company tax rate 30%
Companies required rate of return (RoR) 12% Companies required rate of return (RoR) 12%
Companies cost of capital (CoC) 15% Companies cost of capital (CoC) 15%

Initial year set up costs and notional benefits Year 0 Initial year set up costs and notional benefits Year 0
Purchase Price $500,000 Purchase Price $400,000
Revenue $580,000 Revenue $520,000
Other Revenue $156,000 Other Revenue $156,000
Operating cost – overheads,salaries, marketing $190,000 Operating cost – overheads,salaries, marketing $195,000
Resediual Value at end of life $45,000 Resediual Value at end of life $25,000
Redundancy payout avoided $50,000 Redundancy payout avoided $0

Workings for annual tax savings from depreciation expense Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Workings for annual tax savings from depreciation expense Year 0 Year 1 Year 2 Year 3 Year 4
Annual depreciation expense Reducing Balance Method: $500,000 ¸ 40% $500,000 $300,000 $180,000 $108,000 $64,800 $38,880 Annual depreciation expense Reducing Balance Method: $400,000 ¸ 35% $400,000 $260,000 $169,000 $109,850
Tax savings from depreciation expense 40% $200,000 $120,000 $72,000 $43,200 $25,920 $15,552 Tax savings from depreciation expense 35% $140,000 $91,000 $59,150 $38,448
30% tax rate $60,000 $36,000 $21,600 $12,960 $7,776 $4,666 30% tax rate $42,000 $27,300 $17,745 $11,534
Written Down Value $300,000 $180,000 $108,000 $64,800 $38,880 $23,328 Written Down Value $260,000 $169,000 $109,850 $71,403

Annual Processed Scrap Revenue Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Annual Processed Scrap Revenue Year 0 Year 1 Year 2 Year 3 Year 4
Increases annually by… (+/- 20%) data; what if analysis? 20% Increases annually by… (+/- 20%) data; what if analysis? 20%
Raw materials cost before tax $696,000 $696,000 $696,000 $696,000 $696,000 $696,000 Raw materials cost before tax $624,000 $624,000 $624,000 $624,000
Tax Paid -$208,800 -$208,800 -$208,800 -$208,800 -$208,800 -$208,800 Tax Paid -$187,200 -$187,200 -$187,200 -$187,200
Raw materials cost after tax Before tax cost x (1 – 30% tax rate) $487,200 $487,200 $487,200 $487,200 $487,200 $487,200 Raw materials cost after tax Before tax cost x (1 – 30% tax rate) $436,800 $436,800 $436,800 $436,800

Working Capital (% of scrap revenue) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Working Capital (% of scrap revenue) Year 0 Year 1 Year 2 Year 3 Year 4
After tax sales $580,000 $580,000 After tax sales $624,000 $624,000
Operating cost as a proportion of sales 10% Operating cost as a proportion of sales 10%
After tax operating costs -$58,000 $58,000 After tax operating costs -$62,400 $62,400

Workings for after tax operating costs – overheads, salaries and marketing Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Workings for after tax operating costs – overheads, salaries and marketing Year 0 Year 1 Year 2 Year 3 Year 4
$190,000 $190,000 $190,000 $190,000 $190,000 $190,000 $195,000 $195,000 $195,000 $195,000
-$57,000 -$57,000 -$57,000 -$57,000 -$57,000 -$57,000 -$58,500 -$58,500 -$58,500 -$58,500
Annual Operating Costs $133,000 $133,000 $133,000 $133,000 $133,000 $133,000 Annual Operating Costs $136,500 $136,500 $136,500 $136,500

Workings for Rental Income and Unprocessed Scrap Sales Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Workings for Rental Income and Unprocessed Scrap Sales Year 0 Year 1 Year 2 Year 3 Year 4
Rental and Unprocessed Scrap Income before tax $156,000 $156,000 $156,000 $156,000 $156,000 $156,000 Rental and Unprocessed Scrap Income before tax $156,000 $156,000 $156,000 $156,000 $156,000
Tax Paid $46,800 -$46,800 -$46,800 -$46,800 -$46,800 -$46,800 Tax Paid -$46,800 -$46,800 -$46,800 -$46,800 -$46,800
Rental and Unprocessed Scrap Income after tax $109,200 $109,200 $109,200 $109,200 $109,200 $109,200 Rental and Unprocessed Scrap Income after tax $109,200 $109,200 $109,200 $109,200 $109,200

Workings for capital gains tax to be paid on disposal of machine Workings for capital gains tax to be paid on disposal of machine
Original book value (Year 0) of machine $500,000 Original book value (Year 0) of machine $400,000
Accumulated depreciation after 6 years 6 years x 40% pa $476,672 Accumulated depreciation after 4 years 4 years x $40,000 p.a. $328,598
Book value of machine in Year 6 Cost – accumulated depreciation $23,328 Book value of machine in Year 4 Cost – accumulated depreciation $71,403
Salvage value of machine in Year 6 $45,000 Salvage value of machine in Year 4 $25,000
Capital Gain on Sale of Machine Salvage value ‐ Book value $21,672 Capital Gain on Sale of Machine Salvage value ‐ Book value -$46,403
Tax Paid of CGT -$6,501.60 Tax Payable from Sale -$13,920.75
Salvage value after tax $15,170 Salvage value after tax -$32,482

Below are the questions and answers.

1. Prepare the cash flow table (which incorporates taxes and includes initial investment, operating and terminal cash flows) for each chip crusher using the information given in the case. Which of the following items should be included as incremental cash flows in the table? Give reasons for individual items and list clearly your assumptions in deriving the figures.

a) Yearly interest expense on the fixed-term loan for each machine; No, financing is not included

b) Working capital investment which is 10% of annual scrap revenue; Yes

c) Annual operating costs (i.e. overheads, salaries and marketing) for each machine; Yes

d) The $80,000 that was spent to rehabilitate the plan; No, as that expense occured before the project analysiss was initiated

e) Net income of $120,000 per year from the sales of unprocessed scrap; Yes as this is an opportunity cost

f) Rental income of $36,000 per year. Yes as this is an opportunity cost

2. Which chip crusher (HCC or LCC) would you recommend Nova to purchase based on the payback period (PP), internal rate of return (IRR), net present value (NPV) and equivalent annual value (EAV) methods? All answers are in the working sheets, especially sheet HCC and LCC

[Assume the company is able to invest in both chip crushers on the same terms indefinitely.]

3. Mr Murray requested risk analysis on the project so it is necessary to check which chip crusher (HCC or LCC) made financial sense before it is accepted.

a) Show a sensitivity analysis of NPVs (derived in Question 2) to changes in annual processed scrap revenue and cost of capital individually. Assume each of these variables can deviate from its estimated value by plus or minus 20%. you will find the answer again in sheet +- 20% on the file – you can amend the best and worst case formula via going into Data>What if analysis > Scenario Manager

b) Determine how far the annual net operating cash flow could fall short of forecast before the chip crusher would be rejected. you can work this out otherwise leave it as a heading and blank so we can write up on it after

c) After reviewing the data provided, you realised the revenue and cost figures have not been adjusted for inflation which is another source of uncertainty. Some people were talking about a zero long-term inflation rate, but you wondered what would happen if inflation is 2.5% per annum. this is in the file unde tab 2.5% inflation

4. Consider all information given in the case study and the results derived in Questions 1 to 3. Advise the executive committee and Mr Murray on which chip crusher (LCC or HCC) they should invest. all data is in the file

5. Discuss the reasons for your recommendation and any reservations you may have in given this advice.

You should write 1200 words for 1,2,3,4 questions and 200 words for 5th question

Is this the question you were looking for? If so, place your order here to get started!