Harriman Manufacturing Company, Math Problem Example
- a) –Calculate the expected net cash outlay (the amount of the capital investment) at the beginning of the first year.
Initial Cash Outlay = Purchase Price + Direct Expenses + Capital Expenditures
= $50,000 + $10,000 + 0
= $60,000
- b) – Estimate the net operating cash flows in years 1, 2 and 3, and assume they occur at the end of each year.
The net operating cash flow can be found with the capital budgeting process. Below mentioned chart analyze the whole thing in detail
Worksheet for Computation of Cash Flow | |||||
Year 1 | Year 2 | Year 3 | Year 4 | ||
Investment Y | 60,000 | ||||
Depreciation | 19,800 | 22,110 | 15,376.50 | 2,523.56 | |
Adjusted Basis of Machine | 40,200 | 18,090 | 2,713.50 | 189.95 | |
Inventory | 3,000 | 3,000 | 3,000 | 3,000 | |
Non Interest Bearing | 1,000 | 1,000 | 1,000 | 1,000 | |
Cost Saving | 20,000 | 20,000 | 20,000 | 20,000 | |
Revenue | 20,000 | 20,000 | 20,000 | 20,000 | |
Tax Rate | 8,000 | 8,000 | 8,000 | 8,000 | |
Net Income | 12,000 | 12,000 | 12,000 | 12,000 | |
Add: Depreciation | 19,800 | 22,110 | 15,377 | 2,524 | |
Cash Inflow | 31,800 | 34,110 | 27,377 | 14,524 | |
The depreciation has been computed with the help of MACRS and in the end it added back in the net income to arrive on cash inflow.
- c) – What is the dollar value of the non-operating net cash terminal value (i.e., Salvage Value) during the fourth year?
The salvage as well as gain from selling is mentioned below in the table
Terminal Value Computation | |
Total Value | Salvage Value |
60,000 | 2,523 |
Selling Price | 20,000 |
Gain from Selling | 17,477 |
- d) – If Harriman’s weighted average cost of capital (required rate of return) is 10%, what are the investment’s Net Present Value, Internal Rate of Return, and Simple Payback Period? Should the investment be made?
Net Present Value Computation
Net Present Value (hereafter NPV) is the most widely used tool to assess the economic compatibility of a particular project. Basically the NPV which is also called Net Present worth (NPW) is a time series of cash flows which are both ingoing and outgoing is called NPV. Basically it is the sum of all the present values of the individual cash flows (Edwin & Ruud, 2000). NPV is very useful in the world of finance and has been counted as the central tool to appraise the long term projects with the help of discounted cash flow techniques and time value of money factor.
Net Present Value @ 10% WACC | ||
Initial Outlay | (60,000) | |
Year | Undiscounted Cash Flow | Discounted @ 10% |
1 | 31,800 | 28,909 |
2 | 34,110 | 28,190 |
3 | 27,377 | 20,568 |
4 | 14,524 | 9,920 |
PV | 87,587 | |
Less: Initial Outlay | 60,000 | |
NPV | 27,587 |
Decision: As the NPV is in positive, then the company should take this project.
Internal Rate of Return
Internal Rate of Return (IRR) is another widely used tool to analyze a company or project before taking it. IRR is the rate on which the NPV of the project becomes zero. If the computed IRR comes out greater than the discount or hurdle rate then the project should be taken.
IRR | ||
Undiscounted | Discounted | |
Year | -60000 | -60000 |
1 | 31,800 | 28,909 |
2 | 34,110 | 28,190 |
3 | 27,377 | 20,568 |
4 | 14,524 | 9,920 |
IRR | 32% | 20% |
Decision: As the WACC of the company is 10% and computed IRR is 20%, the company should select the same.
Simple Payback Period
This analyze in how much time the company overcome the initial cost of the project.
Payback Analysis | ||
Undiscounted | Discounted | |
Year | -60000 | -60000 |
1 | 31,800 | 28,909 |
2 | 34,110 | 28,190 |
3 | 27,377 | 20,568 |
4 | 14,524 | 9,920 |
1.07 Years | 3.29 Years | |
The payback period is also good, hence all of the things are in favor of the company; hence the company should invest in this project.
References
Edwin, J & Ruud, T (2000). Project Management & Analysis. New York: McGraw Hill Publications
Fisk, P. (2006). Project Management: An Introductory Review. London: John Wily & Sons Professional Publications.
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