The directors of Aussie Spirit Rowing Ltd are interested in a new type of rowing boat
that ejects a rower when they are exhausted. This new project has caused a lot of
controversy but the directors believe that they can sell 50 units per year to countries
that compete in the sport of international rowing.
The selling price will be $50 000 per unit and the variable costs per unit will be 40
percent of revenue. The product should have a 4-year life. The directors require a
20 percent return on new products such as this one. Fixed cost for the project will be
$750 000 per year. The company will need to invest a total of $1 500 000 in
manufacturing equipment. This equipment may be depreciated at 15 percent straight
line. In 4 years, the equipment will be worth half of what the company paid for it. The
corporate tax rate is 30%.
Required:
a) Prepare a table of Cash Flows
b) Calculate
i) Net Present Value (NPV) $373,814
ii) Internal Rate of Return (IRR) 31.06%
iii) Payback Period 2.53 YEARS
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c) Make recommendations to accept or reject the new project with full explanations
of why the criteria you have used justifies your decision. ACCEPT – HIGH IRR
AND + NPV
Year 0 1 2 3 4
STEP 1 – Calculate Taxable Income
Increased Revenue 2,500,000 2,500,000 2,500,000 2,500,000
Fixed Cost -750,000 -750,000 -750,000 -750,000
Variable Cost
–
1,000,000
–
1,000,000
–
1,000,000
–
1,000,000
Depreciation -225,000 -225,000 -225,000 -225,000
Gain/Loss on Sale for new machine 150,000
Taxable income 0 525,000 525,000 525,000 675,000
Tax @ 30% 0 -157,500 -157,500 -157,500 -202,500
STEP 2 – Include All Cash Flows
Tax refund/paid 0 -157,500 -157,500 -157,500 -202,500
Initial Cost -1,500,000
Increased Revenue 2,500,000 2,500,000 2,500,000 2,500,000
Fixed Cost -750,000 -750,000 -750,000 -750,000
Variable Cost
–
1,000,000
–
1,000,000
–
1,000,000
–
1,000,000
Salvage value of machine 750,000
Net Cash Flow -1,500,000 592,500 592,500 592,500 1,297,500
PVCF @ 20% -1500000 493750 411458 342882 625723
STEP 3 – Make Decision
NPV
373,813.66