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Lahore School of Economics Financial Management II Cash Flow Estimation and Risk Analysis - 2 Assignment 9

This document contains an assignment with problems on cash flow estimation and risk analysis. It provides examples of calculating NPV, IRR, MIRR and payback period for a potential project. It also includes a multi-year example cash flow analysis of replacing an old machine with a new one, showing calculations of investment outflows, revenue increases, depreciation tax savings, salvage values and opportunity costs. The NPV is positive so it recommends proceeding with the replacement.

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Daniyal Ali
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49 views3 pages

Lahore School of Economics Financial Management II Cash Flow Estimation and Risk Analysis - 2 Assignment 9

This document contains an assignment with problems on cash flow estimation and risk analysis. It provides examples of calculating NPV, IRR, MIRR and payback period for a potential project. It also includes a multi-year example cash flow analysis of replacing an old machine with a new one, showing calculations of investment outflows, revenue increases, depreciation tax savings, salvage values and opportunity costs. The NPV is positive so it recommends proceeding with the replacement.

Uploaded by

Daniyal Ali
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Lahore School of Economics

Financial Management II
Cash Flow Estimation and Risk Analysis – 2
Assignment 9
Problems for Assignment

Method 2:

NPV = $80.28 IRR = 12.51%

MIRR:
Terminal value = NFV
CF0 = 0; CF1 = 584; CF2 = 680; CF3 = 440; CF4 = 376; I = 10%; NFV = $2,460.14

PV of cost = -$1,600

N = 4; PV = -1600; FV = 2460.14; I = MIRR = 11.35%.


Payback:
0 1 2 3 4
| | | | |
-1,600 584 680 440 376
Cumulative CF: -1,600 -1,016 -336 104 480

Payback = 2 + $336/$440 = 2.76 years.

Examples
Net cash flow at t = 0:
Purchase price ($8,000)
Sale of old machine 2,500
Tax on sale of old machine (160)
Change in net operating working capital (1,500)
Total investment ($7,160)

Book value of old machine = $ 2,100


Gain on sale = $2,500 - $2,100 = $400
Tax on gain on sale = 0.40($400) = $160

Annual cash inflows:


Sales increase $1,000
Cost decrease 1,500
Increase in pre-tax revenues $2,500

After-tax revenue increase = $2,500(1 – T) = $2,500(0.60) = $1,500.


Depreciation:
Year 1 2 3 4 5 6
New $1,600 $2,560 $1,520 $960 $880 $480
Old 350 350 350 350 350 350
Change $1,250 $2,210 $1,170 $610 $530 $130
Depreciation tax savings $ 500 $ 884 $ 468 $244 $212 $ 52

Depreciation tax savings = Tax rate*(Depreciation) = 0.4(Depreciation).

Year 6:
Recovery of NOWC = $1,500
Sale of replacement machine = $800
Tax on sale of replacement machine = 0.4(Gain on Sale) = 0.4(800 – 0) = $320
AT-Opportunity cost of foregoing right to sell the old machine in Year 6 = $500(1 – 0.4) = $300

0 15% 1 2 3 4 5 6
| | | | | | |
Net investment (7,160)
After-tax revenue increase 1,500 1,500 1,500 1,500 1,500 1,500
Depreciation tax savings 500 884 468 244 212 52
NOWC recovery 1,500
Salvage value of new machine 800
Tax on salvage value of
new machine (320)
Opportunity cost of
old machine (300)
Project cash flows (7,160) 2,000 2,384 1,968 1,744 1,712 3,232
NPV is $921.36. Thus, the replacement should be made.

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