Get instant access to this case solution for only $19

Capital Budgeting Discounted Cash Flow Analysis Case Solution

Solution Id Length Case Author Case Publisher
1259 1211 Words (6 Pages) Thomas R. Piper Harvard Business School : 298068
This solution includes: A Word File A Word File and An Excel File An Excel File

To calculate the net present value of the machine, all the cash inflows and outflows are identified. As shown in Exhibit 1, the cost of the machine is an immediate outflow. The cost benefits are inflow and they are after-tax value has been used. Depreciation is added as it is a non-cash charge. Buying the machine economically is feasible as the NPV is positive and IRR is more than the discount rate. The payback period of 2.25 years is also very appropriate.

31632894575.png
61632894575.png
21632894575.png
41632894574.png
51632894574.png
11632894572.png

Case Analysis for Capital Budgeting Discounted Cash Flow Analysis Case Solution

All the calculations are shown in the Exhibit 1.

Exhibit 1

Tax Rate

40%

 

 

 

 

 

Discount Rate

8%

 

 

 

 

 

 

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

 

$

$

$

$

$

$

Machine Cost

(500,000)

 

 

 

 

 

Depreciation

 

100,000

100,000

100,000

100,000

100,000

Cost Savings After Tax

 

80,000

80,000

80,000

80,000

80,000

Tax

 

 

 

 

 

 

Cash Proceeds on Selling

 

 

 

 

 

75,000

After Tax Salvage Value

 

 

 

 

 

45,000

Total Cash Flows

(500,000)

180,000

180,000

180,000

180,000

225,000

Present value @ 8%

(500,000)

166,667

154,321

142,890

132,305

153,131

NPV

249,314

 

 

 

 

 

IRR

25%

 

 

 

 

 

Cumulative Cash Flows

(500,000)

(320,000)

(140,000)

40,000

 

 

Payback Period

2.25 Years

 

 

 

 

The actual cash flows for using the old machine are only depreciation and the tax savings due to the depreciation expense. The cash flow for each year using the old machine is 28,000 DM. After discounting the cash flows, the net present value of the first alternative which is using the old machine is 222,395 DM.

Now if the machine is replaced, several incremental cash flows would occur. Firstly, the immediate cash outflow will occur which is equal to the cost of the new machine. This outflow will be adjusted by the after tax salvage value of the old machine. This is shown in Exhibit 2. Moreover, the tax savings from incremental depreciation will also be taken into account. Lastly, the labor saving, cash savings and floor space savings are also cash inflows. The actual cash flows for each year as shown in Exhibit 2 are 110,000 DM. After discounting it, the net present value of the new machine comes out to be 557,638 DM. It shows that buying the new machine will bring more economic benefit.

 

After Tax Labor Savings

After Tax Cash Savings

Saving on Space

Incremental Depreciation

Incremental Tax Savings

Total Incremental Cash Flows

Present Value

Year 0

 

 

 

 

 

(324,000)

(324,000)

Year 1

81,000

15,000

3,000

20,000

12,000

111,000

103,738

Year 2

81,000

15,000

3,000

20,000

12,000

111,000

96,952

Year 3

81,000

15,000

3,000

20,000

12,000

111,000

90,609

Year 4

81,000

15,000

3,000

20,000

12,000

111,000

84,681

Year 5

81,000

15,000

3,000

20,000

12,000

111,000

79,141

Year 6

81,000

15,000

3,000

20,000

12,000

111,000

73,964

Year 7

81,000

15,000

3,000

20,000

12,000

111,000

69,125

Year 8

81,000

15,000

3,000

20,000

12,000

111,000

64,603

Year 9

81,000

15,000

3,000

20,000

12,000

111,000

60,377

Year 10

81,000

15,000

3,000

20,000

12,000

111,000

56,427

Year 11

81,000

15,000

3,000

20,000

12,000

111,000

52,735

Year 12

81,000

15,000

3,000

20,000

12,000

111,000

49,285

Machine Cost

(480,000)

 

 

 

 

 

 

After Tax Salvage Value

156,000

 

 

 

 

 

 

NPV

557,638

 

 

 

 

 

 

Exhibit 3 shows the calculation of the cash flows if the product line is not discontinued. The net present value is $7,615,000; it is less than the value if the product line is discontinued. So it is recommended that the product line must be discontinued.

Exhibit 3

 

1998

1999

2000

2001

2002

2003

2004

2005

 

$ 000_

$ 000_

$ 000_

$ 000_

$ 000_

$ 000_

$ 000_

 

Units

1000

1000

1000

1000

1000

1000

1000

 

Unit Price

20

20.6

21

21.15

21.25

21.25

21

 

Sales

20,000

20,600

21,000

21,150

21,250

21,250

21,000

 

COGS

10,000

10,001

10,002

10,003

10,004

10,005

10,006

 

Depreciation

1,057

1,124

1,204

1,304

1,404

1,504

1,504

 

GP

8,943

9,475

9,794

9,843

9,842

9,741

9,490

 

Sell & G Expense

7,000

7,001

7,002

7,003

7,004

7,005

7,006

 

EBIT

1,943

2,474

2,792

2,840

2,838

2,736

2,484

 

Tax

777

990

1,117

1,136

1,135

1,094

993

 

EBIAT

1,166

1,484

1,675

1,704

1,703

1,641

1,490

 

Capex

(400)

(400)

(400)

(400)

(300)

(200)

-

 

Working Capital

3,700

3,811

3,890

3,930

3,963

3,980

3,957

 

NET WC

(108)

(111)

(79)

(40)

(33)

(17)

23

3,957

Net Cash Flows

658

973

1,196

1,264

1,370

1,424

1,513

3,957

Present Value

658

869

954

900

870

808

767

1,790

NPV

7,615

 

 

 

 

 

 

 

Eliminating Product Line

 

Working Capital

3,592

 

After Tax Salvage Value

4,600

 

Total Present Value

8,192

 

Get instant access to this case solution for only $19

Get Instant Access to This Case Solution for Only $19

Standard Price

$25

Save $6 on your purchase

-$6

Amount to Pay

$19

Different Requirements? Order a Custom Solution

Calculate the Price

Approximately ~ 1 page(s)

Total Price

$0

whatsapp chat icon

Hi there !

We are here to help. Chat with us on WhatsApp for any queries.

close icon