Project 1 (half a mark for each part: You must show your working to receive full marks)

Polycorp is considering an investment in new plant of $3 million. The project will be financed with a loan of $2,000,000 which will be repaid over the next five years in equal annual end of year instalments at a rate if 9.5 percent pa. Assume straight-line depreciation over a five-year life, and no taxes. The projects cash flows before loan repayments and interest have been deducted are shown in the table below. Cost of capital is 14.5% pa (the required rate of return on the project). A salvage value of $200,000 is expected at the end of year five and is not included in the cash flows for year five below. Ignore taxes and inflation.

Year Year One Year Two Year Three Year Four Year Five
Cash Inflow 800,000 950,000 855,000 900,000 950,000

You are required to calculate:

(1) The annual loan repayment
(2) Loan repayment schedule showing principle and interest components
(3) NPV of the project
(4) the IRR of the project (your answer should include at least one manual trial to demonstrate that you understand the concept)
(5) AE, the annual equivalent for the project(AE or EAV)
(6) PB, the payback and discounted payback in years (to one decimal place)
(7) ARR, the accounting rate of return (net and gross)
(8) PI (present value index or profitability index)
(9) Is the project acceptable? Provide the decision rule for each of the methods above.
(10) Why or why not (provide a full explanation)?

Project 2
Polycorp Limited Steel Division is considering a proposal to purchase a new machine to manufacture a new product for a potential three year contract. The new machine will cost $1.15 million. The machine has an estimated life of three years for accounting and taxation purposes. Polycorp has elected to use the diminishing value method of depreciation. The contract will not continue beyond three years and the equipment estimated salvage value at the end of three years is $105,000. The tax rate is 29 percent and is payable in the year in which profit is earned. An investment allowance of twenty percent on the outlay is available. The cost of capital is 13.25%pa after tax.

Addition net working capital of $70,000 is required immediately for current assets to support the project. Assume that this amount is recovered at the end of the three year life of the project.

The new product will be charged $53,500 of allocated head office administration costs each year even though head office will not actually incur any extra costs (cash flows) to manage the project. This is in accordance with the firm’s policy of allocating all corporate overhead costs to divisions.

Extra marketing and administration cash outflows of $43,000 per year will be incurred by the Steel Division. These are tax deductible in the year that they are incurred.

An amount of $39,000 has been spent on a pilot study and market research for the new product. The projections provided here are based on this work.

Projected sales for the new product are 30,000 units at $125 per unit per year. Cash operating expenses are estimated to be 81 percent of sales (excludes marketing and administration, and head office items).

Except for initial outlays, assume cash flows occur at the end of each year (unless otherwise stated). Assume diminishing value depreciation for tax purposes.

Please use diminishing balance/reducing balance depreciation for tax purposes

(a) Construct a table showing your calculations of net cash flow after tax. (Similar to that demonstrated in the notes and in class) {3 marks}
(b) Calculate the NPV. Is the project acceptable? Why or why not? {1 marks}
(c) Explain your calculation of relevant net cash flows after tax, justifying your selection of cash flows. Be sure to state clearly any assumptions made. {1 marks}