TUTORIAL: Capital budgeting: Cash flow principles

QUESTION 1
Use the following information to answer the next 4 questions.
A firm is trying to determine whether to purchase a new machine. The proposed machine has a purchase price of
RM200,000, installation costs of RM50,000 and shipping cost of RM20,000. It also require an additional cost of RM30,000
training. The machine will be depreciated over its six year life using the simplified straight-line method. The new machine is
expected to increase sales by RM200,000 and cost of maintenance by RM50,000 annually over the life of the asset. Due
to increase sales, the firm expects an increase in working capital during the machines life of RM40,000 and the firm
expects to be able to sell the machine for RM10,000 at the end of its life. Finally, to purchase the new machine, the firm
would have to borrow RM30,000 at 7% interest from its local bank, resulting in additional interest payments of RM3,200
per year. The firms marginal tax rate is 40% and its required rate of return is 10%.

a) Calculate initial outlay

RM340,000

b) Calculate operating cash inflows.

RM108,000

c) Calculate terminal cash flow (including operating cashflow)

RM46,000 + RM108,000

d) Calculate the net present value the above proposed machine. Should this machine be purchased?

RM156,339.40; Yes

QUESTION 2
Use the following information to answer the next 4 questions.
A firm is trying to determine whether to purchase a new machine. The proposed machine has a purchase price of
RM20,000, installation costs of RM10,000 and shipping cost of RM2,000. It also require an additional cost of RM3,000 for
training. The machine will be depreciated over its four year life using the simplified straight-line method. The new machine
is expected to increase sales by RM50,000 and cost of maintenance by RM40,000 annually over the life of the asset. Due
to increase sales, the firm expects an increase in working capital during the machines life of RM5,000 and the firm expects
to be able to sell the machine for RM10,000 at the end of its life. Finally, to purchase the new machine, it appears that the
firm would have to borrow RM24,000 at 7% interest from its local bank, resulting in additional interest payments of
RM3,200 per year. The firms marginal tax rate is 40% and its required rate of return is 14%.

a) Calculate initial outlay

RM40,000

b) Calculate operating cash inflows.

RM9,200

c) Calculate terminal cash flow (including operating cash flow)

RM11,000 + RM9,200 = RM20,200

d) Calculate the net present value the above proposed machine. Should this machine be purchased?
-RM6,680.86; No

DDPW2133 INTRODUCTION TO FINANCE

QUESTION 3
Use the following information to answer the next 4 questions.
A firm is trying to determine whether to replace an existing machine. The proposed machine has a purchase price of
RM350,000, installation costs of RM15,000 and shipping cost of RM25,000. It also require an additional cost of RM10,000
for training. The machine will be depreciated over its five year life using the simplified straight-line method. The new
machine is expected to increase annual sales from RM450,000 to RM550,000. But it is also increase cost of maintenance
from RM350,000 to RM400,000 annually over the life of the asset. Due to increase sales, the firm expects an increase in
working capital during the machines life of RM44,000 and the firm expects to be able to sell the machine for RM8,000 at
the end of its life. The existing machine was originally purchased two years ago for RM300,000, has a remaining life of
three years, and is being depreciated using the simplified straight line method. The expected salvage value at the end of
the machines life is zero, however the current sales price of the existing machine is RM120,000. Finally, to purchase the
new machine, it appears that the firm would have to borrow RM22,000 at 7% interest from its local bank. The firms
marginal tax rate is 40%. and its required rate of return is 12%.

a) Calculate the initial outlay

RM300,000

b) Calculate the incremental operating cash flow

RM37,200

c) Calculate the terminal cash flow (including operating cash flow)

RM48,800 + RM37,200

d) Calculate the net present value the above proposed machine. Should this machine be purchased?
-RM138,212 ; No

QUESTION 4
Use the following information to answer the next 4 questions.
A firm is trying to determine whether to replace an existing machine.The proposed machine has a purchase price of
RM30,000, installation costs of RM5,000 and shipping cost of RM2,000. It also require an additional cost of RM3,000 for
training. The machine will be depreciated over its 4 year life using the simplified straight-line method. The new machine is
expected to increase sales by RM12,000 and cost of maintenance by RM4,000 annually over the life of the asset. Due to
increase sales, the firm expects an increase in working capital during the machines life of RM1,000 and the firm expects to
be able to sell the machine for RM5,000 at the end of its life. The existing machine was originally purchased five years ago
for RM40,000, has a remaining life of three years, and is being depreciated using the simplified straight line method. The
expected salvage value at the end of the machines life is zero, however the current sales price of the existing machine is
RM20,000. Finally, to purchase the new machine, it appears that the firm would have to borrow RM22,000 at 7% interest
from its local bank. The firms marginal tax rate is 40%. and its required rate of return is 10%.

a) Calculate the initial outlay

RM23,000

b) Calculate the incremental operating cash flow

RM6,500

c) Calculate the terminal cash flow (including operating cash flow)

RM4,000 + RM6,500

d) Calculate the net present value the above proposed machine. Should this machine be purchased?
RM6,676.15 ; Yes

DDPW2133 INTRODUCTION TO FINANCE