The cash flow forecasts for two mutually exclusive projects are as follows:
Cash Flow in Dollars
Year Project A Project B
0 -$100 -$100
1 30 49
2 50 49
3 70 49
Note : Use a table to illustrate your answer
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
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Which project would you choose if the opportunity cost of capital is 5 percent?
Show calculations to support your answer.
Which would you choose if the opportunity cost of capital is 12 percent?
Show calculations to support your answer.
Why does your answer change? Indicate the interest rate where your answer
changes 7.796% Use a graph to illustrate answer
PROJECT A
PROJECT B
5% 34.39 33.43
12% 16.47 17.69