DELTA CORPORATION PROJECT

Delta Corporation is considering an investment proposal (the Delta Project) to expand one of it
lines. The project is planned to start by the beginning of 2001.The initial capital outlay in the fir
$ 1 million. At the end of year 3, another capital expenditure of $ 0.5 million is required for an
The economic life of the project is estimated to be eight years .The level of working capital is ta
below .

Year 0 1 2 3 4 5
WC 2000 2500 3100 3600 4000 4300

The salvage value of the total capital expenditure ($1.5 million) at the end of the eighth year is
estimated as $ 16000.The depreciation rate for initial investment, for tax purposes is 12.5 per c
annum. The upgrade depreciates at $ 100,000 per year for years 4 to 8.
The forecast sales for the project are to be based on a time trend regression on the companys
seven years of sales shown in Table below.

Delta Corporations historical sales

Sales
Year (Units)
1990 500,000
1991 550,000
1992 540,000
1993 560,000
1994 565000
1995 590,000
1996 600,000
1997 610,000
1998 615559
1999 669000
2000 700,000

Forecast sales obtained from the time trend regression are to be adjusted from year 4 onwards
account for the increased sales resulting from the upgrade, which are estimated as 500,000 un
year. The selling price of the product is expected to be 50 cents per unit for the first five years
cents thereafter .The production cost is estimated to be 10 cents per unit. Other operating cost
do not include depreciation) are $ 50,000 per year for the first five years and $ 55000 per year
rest of the project life. The corporate tax rate is 30 per cent.
Show detailed cash flow analysis and would you accept the project if the cost of capital (disco
SOLUTION

Delta Project Analysis

 Year 0 1 2 3 4 5
minus 1 Capital Outlay 1000000
2 Upgrade 500000
3 ATSV
4 WC 2000 500 600 500 400 300
Outflow 5 Cash flow : capital 1002000 500 600 500500 400 300

Operating flows
6 Forecast sales unit 691,106 707,812 724518 741224 757931
7 Extra sales unit 500,000 500,000
8 Total sales Unit 691,106 707,812 724,518 1,241,224 1,257,931
9 Unit selling Price 0.5 0.5 0.5 0.5 0.5
10 Sales Income 345553 353906 362259 620612 628965.5
11 Unit Cost 0.1 0.1 0.1 0.1 0.1
12 Production cost 69110.6 70781.2 72451.8 124122.4 125793.1
13 Other Cost 50,000 50,000 50,000 50,000 50,000
14 Total Cost 119,111 120,781 122,452 174,122 175,793
15 Depreciation Initial 125000 125000 125000 125000 125000
16 Depreciation upgrade 100,000 100,000
17 Taxable Income 101,442 108,125 114,807 221,490 228,172
18 Tax Payable 30432.72 32437.44 34442.16 66446.88 68451.72
19 Net Income 71,010 75,687 80,365 155,043 159,721
20 Cash flow:operations 196,010 200,687 205,365 380,043 384,721
21 Net Cash flow -1002000 195,510 200,087 -295,135 379,643 384,421

NPV $237,651.65
ACCEPT THE PROJECT

ATSV After tax salvage Value

After tax salvage value Proceeds from sale of assets -taxes on sale of assets
16000-4800 11200

Taxes on sale of assets =( sales proceeds-book value )* Tax rate

(16000-0)0.30 4800

Book Value Cost -Allowable accumulated depreciation

100,000-(100,000*0.125*8) 0
a Project) to expand one of its product
initial capital outlay in the first year is
0.5 million is required for an upgrade.
level of working capital is tabulated

6 7 8
4500 3000 0

the end of the eighth year is

or tax purposes is 12.5 per cent

egression on the companys last

djusted from year 4 onwards to

are estimated as 500,000 units per
er unit for the first five years and 75
er unit. Other operating costs (which
years and $ 55000 per year for the

ct if the cost of capital (discount rate) is 15%

 6 7 8

11200
200 1500 3000 2000
200 1500 14200 500
600
500
774637 791343 808049 400
500,000 500,000 500,000 300
1,274,637 1,291,343 1,308,049 200
0.75 0.75 0.75 -1500
955977.8 968507.3 981036.8
0.1 0.1 0.1 3000
127463.7 129134.3 130804.9
55,000 55,000 55,000
182,464 184,134 185,805
125000 125000 125000
100,000 100,000 100,000 1000000
548,514 559,373 570,232 12.50%
164554.2 167811.9 171069.6 125000
383,960 391,561 399,162
608,960 616,561 624,162
608,760 618,061 638,362

16000
0.3
4800
 REPCO REPLACEMENT PROJECT

Repco Corporation is considering a replacement investment. The machine currently in use was
purchased two year ago for $ 49,000. Depreciation for tax purposes is $ 9800 per year for five years .The
market value of this machine now is $ 35000. The new machine will cost $123,000 and requires $3000
for installation .Its economic life is estimated to be three years and tax allowable depreciation is $ 42000
per year for three years .If the new machine is acquired, the investment in accounts receivables is
expected to rise by $ 8000 , the inventory by $ 25000 and accounts payable by $ 13000. The annual
income before depreciation and taxes is expected to be $ 65000 for the next three years with the old
machine and $ 122,000, $ 135,000 and$ 130,000 for the I,II and III years respectively with the new
machine. The salvage values of the old and new machines three years from today is expected to be $
3500 and $ 4000 respectively. The income tax rate is 25 per cent
FIND THE TOTAL CASH FLOWS FROM THE PROJECT

SOLUTION
Repco Replacement Investment Project

Initial Investment
Cost of new machine 123,000
plus Installation 3000
minus Proceeds from sale of old machine 35000
plus Taxes on sale of old machine 1400
plus change in working capital 20,000
Initial Investment 112,400

Taxes on sale of old machine ( sale proceeds -Book value )* tax rate

(35000-29400)* 0.25
1400

Book Value Cost- Tax allowable accumulated depreciation

49000- ( 9800*2) 29400

Table Repco Replacement Investment Project : Incremental Operating cash flows ($)

I II III
New Machine
1 Operating Income 122000 135000 130000
2 Depreciation 42000 42000 42000
 3 Income before tax 80000 93000 88000
4 Tax @ 25% 20000 23250 22000
5 Income after tax 60000 69750 66000
6 Operating cash flows (5+2) 102000 111750 108000

Old Machine
1 Operating Income 65000 65000 65000
2 Depreciation 9800 9800 9800
3 Income before tax 55200 55200 55200
4 Tax@25% 13800 13800 13800
5 Income after tax 41400 41400 41400
6 Operating cash flows 51200 51200 51200

Incremental

1 New Machine 102000 111750 108000

2 Old Machine 51200 51200 51200
3 Incremental cash flow 50800 60550 56800

Repco Replacement Investment Project :Terminal cash flow

plus Proceeds from sale of new machine 4000

minus proceeds from sale of old machine 3500
minus taxes on sale of new machine 1000
plus taxes on sale of old machine 875
plus recovery of working capital 20000

20375

Taxes on sale of new machine (sale proceeds-book value )* tax rate

(4000-0)* 0.25 1000

Book value cost -tax allowable accumulated depreciation

126000-(42000*3) 0

Taxes on sale of old machine (sale proceeds -book value)* tax rate

(3500-0)*0.25 875
Book value cost -tax allowable accumulated depreciation

49000-(9800*5) 0
or five years .The
requires $3000
ciation is $ 42000

The annual
s with the old
th the new
pected to be $
 Repco Replacement Investment Project : Overall cash flow ($)

Year 0 Year 1 Year 2 Year 3

Initial Investment -112400

Operating cash flow 50800 60550 56800

Terminal cash flows 20375

Total cash flows -112400 50800 60550 77175