The company Derabel, S.A. is considering buying a new machine for its production process. This project means an initial cost of € 200,000 and the machine is estimated to have a useful life of 5 years. The maximum productive capacity of the machine is 200,000 units per year. However, in the first year, it is expected that the activity will be 70% of the maximum installed capacity, reaching 100% from the second year. During the first year, the unit sales price will be € 2.50, the unit variable cost € 1.50 and the fixed annual cost € 60,000, resulting in cumulative yearly increases of 4% in the price of the product sale, 3% on variable costs, and 2% on fixed costs. Also, it is assumed that: The company uses a linear depreciation system, and the residual value of the machine is € 25,000. Besides, the sale value of the machine at the end of its physical life will be € 30,000 which will be charged in cash. The nominal discount rate (kN) used by the company is 8% per year and constant for the planned period. The tax rate that taxes the benefits is 25%. Taxes are paid in the period following their accrual. All production is sold in the reference period. All income and expenses are charged and paid in cash. With the above data, determine the Net Cash Flows after taxes of the project described above. Calculate the net absolute return.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section10.A: Mutually Exclusive Investments Having Unequal Lives

Problem 2P

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The company Derabel, S.A. is considering buying a new machine for its production process. This project means an initial cost of € 200,000 and the machine is estimated to have a useful life of 5 years. The maximum productive capacity of the machine is 200,000 units per year. However, in the first year, it is expected that the activity will be 70% of the maximum installed capacity, reaching 100% from the second year.

During the first year, the unit sales price will be € 2.50, the unit variable cost € 1.50 and the fixed annual cost € 60,000, resulting in cumulative yearly increases of 4% in the price of the product sale, 3% on variable costs, and 2% on fixed costs.

Also, it is assumed that:

The company uses a linear depreciation system, and the residual value of the machine is € 25,000. Besides, the sale value of the machine at the end of its physical life will be € 30,000 which will be charged in cash.
The nominal discount rate (kN) used by the company is 8% per year and constant for the planned period.
The tax rate that taxes the benefits is 25%. Taxes are paid in the period following their accrual.
All production is sold in the reference period.
All income and expenses are charged and paid in cash.

With the above data, determine the Net Cash Flows after taxes of the project described above. Calculate the net absolute return.

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