Project Evaluation for a Manufacturing Firm in Brisbane
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Added on 2023/06/11
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This article provides a detailed analysis of the project evaluation for a manufacturing firm in Brisbane. It includes the computation of after-tax profits, depreciation, NPV, IRR, and payback period. The feasibility of the project is evaluated based on different criteria such as NPV, IRR, and PI.
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Question 1 a)As per the given details, a Brisbane based manufacturing firm intends to setup a new plant which would have an estimate life of 10 years. The summary of the expected cash flows as provided is detailed below. For the given project, an upfront cost of $ 3 million would be required. It is expected that at the end of useful project life, the salvage value (post tax) of the equipment purchased at t=0 would be $ 200,000 or $ 0,2 million. Also, it is known that at t-5, the machine would require refurbishment which would lead to an incremental cash flow of $ 2 million Besides, it is known that for all the 10 years of useful life of the project, the after tax profits generated would be $ 0.7 million annually. One of the pivotal elements which is taken as a cost for computation of after tax profits is depreciation. Thus, in the computation of $ 0.7 million annual after tax profits, depreciation has been deducted. However, depreciation is a non-cash based expense and hence needs to be added back (Damodaran, 2015). Equipment Initial Cost = $ 3 million Salvage Value = $ 0.2 million Annual Depreciation using the straight line method = (3-0.2)/10 = $ 0.28 million However, incremental expenditure of $ 2 million has been incurred at t=5, hence this amount would be added to the depreciation in the later years (Petty, et. al., 2015). Thus, incremental depreciation from 6thyear onwards = 2/5 = $ 0.4 million From the above discussion, the following depreciation would be added so as to obtain the project cash flows. From t=1 to t=5, annual depreciation charge = $ 0.28 million From t =6 to t=10, annual depreciation charge = $ 0.28 + $0.4 = $ 0.68 million Considering the above, the project cash flows are estimated below.
b)The discount rate for the project has been estimated as 10%. Using the NPV function in excel and the above cash flows from the project, the NPV has been estimated as $2.8 million. The decision criterion based on NPV is that the value should be higher than zero which the given project manages to do (Parrino and Kidwell, 2014). Hence, it is feasible as per NPV criterion. c)The IRR for the given project has been computed based on the project cash flows part(a) and also the IRR function available in excel. The IRR yielded from this computation is 27.25% which is greater than the discount rate of 10% for this project. The decision criterion based on IRR is that the value should be higher than discount rate which the given project manages to do (Damodaran, 2015). Hence, it is feasible as per IRR criterion. Also, the profitability index for the project has been derived as 1.93. As it has managed to cross the hurdle rate of 1, hence the proposed project would be feasible in accordance with PI criterion. d)To aid the payback period computation, the following table is useful. Payback period = 3+ (0.06/0.98) = 3.06 years
The proposed project would be considered feasible as payback period is lower than useful project life which is 10 years (Brealey, Myers and Allen, 2015).
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References Brealey, R. A., Myers, S. C., and Allen, F. (2015)Principles of corporate finance,2nd ed. New York: McGraw-Hill Inc. Damodaran, A. (2014).Applied corporate finance: A user’s manual3rd ed. New York: Wiley, John & Sons. Parrino, R. and Kidwell, D. (2014)Fundamentals of Corporate Finance,3rd ed. London: Wiley Publications Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., and Nguyen, H. (2015).Financial Management, Principles and Applications, 6thed.. NSW: Pearson Education, French Forest Australia.