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Assignment 4 Corporate Finance

Assignment 4 Corporate Finance

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Published by: Prashanth Annamreddi on Nov 29, 2012
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Make Cash Flows

Year 1 Direct Costs Raw Materials Total Costs Tax Deductibility (35%) Total After Tax Costs Depreciation Depreciation Tax Shield Working Capital Return 50000 40000 90000 31500 58500 5000 1750 0 Year 2 50000 40000 90000 31500 58500 5000 1750 0 Year 3 50000 40000 90000 31500 58500 5000 1750 0 Year 4 50000 40000 90000 31500 58500 5000 1750 0 Year 5 50000 40000 90000 31500 58500 5000 1750 0 Year 6 50000 40000 90000 31500 58500 5000 1750 0 Year 7 50000 40000 90000 31500 58500 5000 1750 0 Year 8 50000 40000 90000 31500 58500 5000 1750 5000

Total Cash Flow Discount Rate Present Value of CF

-56750 1.20 -47291.66

-56750 1.44 -39409.72

-56750 1.73 -32841.43

-56750 2.07 -27367.86

-56750 2.49 -22806.55

-56750 2.99 -19005.46

-56750 3.58 -15837.88

-51750 4.30 -12035.39

Total Net Present Value

-216595.97

58 -15237.44 -37430.30 -9802.99 -18285.49 -21942.73 -31192.42 -54600 3.00 .67 -54600 2.55 -53900 1.12 -53900 2.44 -3807.74 Net Present Value of Cash Flow from change in Warehouse Expansion Total NPV -210409.20 -44916.51 -54600 2.07 -25993.85 -42150 4.66 -53900 1.Buy Cash Flows Now Total Costs Tax Deductibility (35%) Total after tax costs Machinery Buy New 8000 Sell Old 5000 Book Loss 35000 Tax Saving 12250 Total Machinery CF 9250 Depreciation on New Machinery Depreciation Tax Shield Excess salary After Tax cost of salary Extra Working Capital WC returned 5000 WC required 12450 Total Working Capital CF 7450 Total Cash Flow Discount Rate Present Value of Cash Flow -1800 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 83000 83000 83000 83000 83000 83000 83000 83000 29050 29050 29050 29050 29050 29050 29050 29050 53950 53950 53950 53950 53950 53950 53950 53950 2000 700 1000 650 2000 700 1000 650 2000 700 1000 650 2000 700 1000 650 1000 650 1000 650 1000 650 1000 650 12450 -53900 1.

Total Cash Flow every year comes to 56750.97 as the Net Present Value of the cost of the production. 4. The negative sign indicates that the amount will be an outflow on our part without considering the margins and the end prices of selling the product. At the end of the project we will need to get the cost of working capital that is 2 weeks of raw materials and finished products. We need not include the building or any other infrastructure. . To calculate the depreciation tax shield we need to know the yearly depreciation on the machinery alone. 2.Make Product Cash Flow Explanations For the Cash Flows and the Net Present Value calculations in the Make product decision there are 4 major factors that would affect the NPV. as they would be part of sunk costs. Yearly costs of raw materials are 40000 and cost of finished products is 90000. Total Costs Taxation Rate to calculate Tax deductibility of expenses Depreciation Working Capital From the assigned reading it can be clearly understood that the total costs consist of the Direct Manufacturing Costs and the Raw Materials Cost. We shall arrive at a figure of 216595. 3. The taxation rate is stated as 35% so after the tax deductibility of expenses we are left with the after tax expenses as 58500. We do not know the direct cost of the working capital so we will try to estimate it from the yearly cost of raw materials and finished products. The yearly depreciation is 5000 as the useful life of the machinery is 8 years and the book value is given as 40000. 1. This amounts to 90000 every year. We shall discount at a rate of 20% as it is specified as the company’s cutoff rate of return. Calculating the value of 2 weeks worth of the same will give us the following WC of raw materials = 2/52 X 40000 WC of finished product = 2/52 X 90000 Total WC = 2/52 X 130000 = 5000 Using the above information we can find the Net Present Value of the costs of making the product in house for the next 8 years. After applying the tax rate the tax shield is 1750.

We have to maintain a higher inventory/stock than if united metal manufactured so the change in working capital has to be accounted for so the changes have to be done and reimbursed ant the end of the project. 4.Buy Product Cash Flows Explanations For the Cash Flows and the NPV costing of the in the Buy the production decision is based on several cash flows. Total Costs Excess Salary to be paid Change in Working Capital Change in Cash Outlay due to early expansion of Warehouse Depreciation Tax Shield Tax Rate New Machinery Costs and Associated Depreciation The total costs will be reduced to 83000. We will need to buy a new machinery costing 8000 that we will have to depreciate in a straight-line method for 4 yrs. The difference in the net present value of the warehouse expansion in the 3rd and 4th year has been calculated as 3807. 6.67 The figure has been calculated by assuming an outflow of 50000 and depreciated over 25 years and calculating the NPV of the expansion project in the 3rd and the 4th years. When we buy the production from Amalgamated Components we have to re-assign the chief operator to a job with an advised salary of 7000 and his current contract states he is to be compensated 8000 so the extra salary has to be accounted for the project costs and the tax deductibility has to be done. 2. 7. The loss is 35000 so the tax benefit can be calculated as 35% of 35000 that will be 12250. The warehouse has to be expanded in the 3rd year rather than in the 4th year we should account for the change in the net present value due to earlier expenses. 5. 1. 3. The Working capital required to maintain an average inventory/stock of 15000 items at the rate of 83 cents per item is 12450. Then the NPV in the current year has been calculated and the difference has been shown in the calculations. So calculating the after tax costs of buying we get 53950. . The book value of the loss in the sale of the machinery should be accounted for and the tax benefit for the loss should appear on the books.

If the production is outsourced the contract could turn out to be costly in the long run as Amalgamated Components can dictate the terms of the contract and charge higher prices at renewal of the contract. So although both the decisions are equally viable the decision should be based on both the quality and the company’s decision on outsourcing the production.Arbitration between the Buy or Make decision. Also if there was a competition between suppliers(Amalgamated Components) then the price could go down further and hence make the Buy decision much more viable. . The NPV of both the decisions are almost similar. The difference is slightly above 3% of the entire NPV.

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