Project 1

Polycorp is considering an investment in new plant of $3.1 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 of 8.5 percent pa. Assume straight-line depreciation over a five-year life, and no taxes. The projects cash flows before loan repayments and interest are shown in the table below. Cost of capital is 12.35% pa (the required rate of return on the project). A salvage value of $255,000 is expected at the end of year five and is not included in the cash flows for year five below. Ignore taxes and inflation.

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Year Year One Year Two Year Three Year Four Year Five
Cash Inflow 850,000 850,000 800,000 930,000 950,000

You are required to calculate:
(1) The amount of the annual loan repayment and a repayment schedule.
(2) NPV of the project
(3) the IRR of the project
(4) AE, the annual equivalent for the project(AE or EAV)
(5) PB, the payback and discounted payback in years (to one decimal place)
(6) ARR, the accounting rate of return (gross and net)
(7) PI (present value index or profitability index)
(8) Is the project acceptable? You must provide a decision or explanation for each of the methods in parts (2) to (7). Why or why not (provide a full explanation)? Also a brief explanation of your treatment of Salvage Value and Loan repayments is required.

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 $1.112 million. The machine has an estimated life of three years for accounting and taxation purposes. The contract will not continue beyond three years and the equipment estimated salvage value at the end of three years is $118,000. The tax rate is 27 percent and is payable in the year in which profit is earned. An investment allowance of twenty five percent on the outlay is available. The after tax cost of capital is 13.45%pa. Addition net working capital of $75,000 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 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 $44,500 per year will be incurred by the Steel Division for the project. An amount of $59,000 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 32,000 units at $136 per unit per year. Cash operating expenses are estimated to be 77 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.

(a) Construct a table showing your calculations of net cash flow after tax (NCFAT).
(b) Calculate the NPV. Is the project acceptable? Why or why not?

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