Demonstration question about estimating project cash flows BBC – III

EXERCISE QUESTION ABOUT ESTIMATING PROJECT CASHFLOWS

SNACK-Corner Restaurant is proposing to acquire a new snack vending machine at a cost of Ugx.
45,000,000. The company just completed a Ugx. 4,500,000 feasibility study to analyze the decision to
buy the vending machine. Recommendations from the feasibility studiy indicated that the machinery
should be exclusively financed by a loan obtained from Tropical Bank while other costs be financed with
owner’s equity. The interest rate (required rate of return-RRR, discount rate, borrowing rate, yield
rate, cost of capital) the company pays on its borrowings is 23%. The expected life of the project will
be six years with a residual value of 25.5% of the loan amount.

It will cost Ugx. 8,125,050 to transport (carriage, shipping or freight charges) the machine. Insurance
and inspection costs are expected to be 12% of the invoice (price) value and Usd. 1,500, respectively.
Ugx. 1,850,000 and 3.5% of the asset price value would be spent on clearing charges and import duty
respectively. Handling costs (loading and offloading) which would otherwise have been Ugx. 750,000
were not paid since tasks were executed by persons friendly to the managing director at no cost. The
company was exempted from paying 3.8% infrastructure levy by URA. Net working capital is expected
to increase by Ugx. 4,000,000.

Once production commences, the machine is expected to generate 2,850 pieces of Candy Bars in the first
year expected to rise at an average inflation rate of 6% up to the 3rd year and then becomes constant in
4th and 5th year, thereby falling by 2% in the final year of the investment. Each Candy bar is expected to
be sold at Ugx. 17,500 in year one and two, then fall by 5% for each of the rest of the periods. The
monthly cash savings are expected to be Ugx 128,000 in the first year, rising by Ugx. 54,000 every year.
The new investment will generate an extra revenue of Ugx. 12,800,000. License and administrative costs
are expected to be Ugx. 280,000 per month and Ugx. 1,250,000 respectively. Licensing and
administrative costs are subject to inflation, which is judged to be around 5% over the period.

The material and lighting costs are expected to be Ugx. 250 and Ugx. 220 per unit output produced
respectively. The company is also expected to spend Ugx. 547,000 per quarter, Ugx. 2,550,074 per
annum, Usd. 582.00, on marketing, distribution and rent respectively which are fixed for the entire
project life. The cost of maintenance is estimated to be in each of the first two years, Usd. 600.00 in year
three, Usd. 704.00 in year four and fall by 2% in the rest of the years. The annual Depreciation is
determined on a straight line basis while taxation on profits is at a rate of 35%. The exchange rate for $
1 (dollar) is at Ugx. 4,520.

Required;
a) Extract a projected Cash flow statement for the above project and use it to compute for all the relevant
cash flows.
b) Advise the management of SNACK-Corner Restaurant on what action should be taken regarding this
project, basing on the computed NPV, IRR, PV and ARR. Provide decision support models to
support your advice.

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Prepared By Ddamba AbdulKarim ©2018
Department of Applied Computing & Information Technology
Faculty of Computing and Informatics
Makerere University Business School