INTRODUCTION:

The LSC Corporation is considering investing in a new piece of machinery that will cost the firm £100,000. It will remain operational for eight years, and will be scrapped at the end of the eighth year. It will generate annual revenues of £70,000 over that period, and will incur annual costs of £50,000 over the same period. Its salvage value at the end of the eight years is £5,000.

The company's cost of capital is 10 per cent and the firm has a tax rate of 36 per cent

CALCULATION OF THE TOTAL PRESENT VALUE OF PROJECTS CASH FLOWS

Year

0

1

2

3

4

5

6

7

8

(100,000)

Revenues

70,000

70,000

70,000

70,000

70,000

70,000

70,000

70,000

Expenses

(50,000)

(50,000)

(50,000)

(50,000)

(50,000)

(50,000)

(50,000)

(50,000)

Gross profit

20,000

20,000

20,000

20,000

20,000

20,000

20,000

20,000

Tax@36%

(7,200)

(7,200)

(7,200)

(7,200)

(7,200)

(7,200)

(7,200)

(7,200)

Profit after tax

12,800

12,800

12,800

12,800

12,800

12,800

12,800

12,800

Tax relief on CCA@36%

3,600

6,480

5,184

4,147

3,318

2,654

2,123

1,698

Scrap value

5,000

Net Cash flow

(100,000)

12,800

16,400

19,280

17,984

16,947

16,118

15,454

19,923

Present value factor@10%

1.000

0.909

0.826

0.751

0.683

0.621

0.564

0.513

0.467

Present value

(100,000)

11,635

13,546

14,479

12,283

10,524

9,091

7,928

9,304

Total Present Value

89510

Revenue from scrap

5000

Net Present Value

[5490]

CALULATIONS:

Gross profit: Revenues - Expenses, 70,000- 50,000 = 20,000

Tax is calculated on the Gross profits at the progressive rate basis.

Tax Relief is considered on the Capital Consumption Allowance as that much tax can be claimed as exempt & will be added in the Net Cash Flows of the corporation.

Calculation of the Present Value factors @ 10%

Formula -

FV = PV (1+R) N

FV = Future Value

PV = Present Value

R = Rate of Interest

N = Period of year.

Therefore, PV = FV

-----------------------

(1 + R) N

PV = 1

--------------------

( 1 + 10/100)1

PV = 1

--------------------

110/100

PV = 100/110

PV = 0.909 - Ist yr.

PV = 0.909 X 100/110

= 0.826 - IInd yr.

PV = 0.826 X 100/110

= 0.751 - IIIrd yr.

PV = 0.751 X 100/110

= 0.683 - IVth yr.

PV = 0.683 X 100/110

= 0.621 - Vth yr.

PV = 0.621 X 100/110

= 0.564 - VIth yr.

PV = 0.564 X 100/110

= 0.513 - VIIth yr.

PV = 0.513 X 100/110

= 0.467 - VIIIth yr.

PV = 0.467 X 100/110

= 0.424 - IX th yr.

Present Value of each year is calculated with the multiplication of Annual Net cash flow & Present Value factor @ 10% of each year.

Grand total of the present values of all 9 years is the Total Present Value of the project.

IMPACTS OF THE CAPITAL CONSUMPTION ALLOWANCE ON THE FIRMS's CASH FLOWS:

Capital Consumption Allowance

will be treated on account of the wear & tear of asset during the period. Tax Relief @36% can be claimed on that much portion of allowance & it can be added in the Net cash inflow of the business. Due to which earnings per annum of the corporation are increased which are leading to the commensurate appreciation in the Total present value of the project during the period.

NET PRESENT VALUE OF THE PROJECT & INVESTMENT DECISION:

Net Present Value

of the project is calculated based on the calculation of the Total present value as above. The value of the scrap machine are required to be added in this value as it increases the revenue generation of the firm at the end of the projected life of asset. From this added value investment of the project is subtracted to arrive at the net present value of the project.

Investment Decision

in the projected activity is to be taken on the basis of the calculation of the Net Present Value of asset. In this project Net Present Value of asset is negative i.e. [5490] which shows it would be resulting into losses if the project has been undertaken. It is therefore as per the measurement of the financial planning & decision-making there are modifications are to be made in the project plannings.The determined project is not suitable, feasible, acceptable & commensurate in the prospective period.

CONCLUSION

Calculation of the Net present Value is one of the important measures of the assessment of the viability of the project. It determines the worth of the project planning's & costs calculations in the prospective periods of the business. Tax calculations are feasible to be considered in the calculation of the net inflow of the projected activity in the assessment of the rational project planning.

Source: Essay UK - http://turkiyegoz.com/free-essays/finance/strategic-financial-management.php


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