Financial Management

Assignment no:6

By : Beshoy Tadros

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It’s highly recommend to choose machine no.1 as it has the higher NPV based on
the following analysis.

• Calculating the cost of Common Stocks:

RE = Rf + B ( Rm - Rf ) = 0.07 + 2 *( 0.12 - 0.07 ) = 0.17

• Calculating the cost of Preferred Stocks:

Rp = D/P0 = 0.15

• Calculating cost of Bond after tax :

Cost of bond after tax = Cost of bond before tax * (1 - Tax rate )
= 0.11*(1-0.2) = 0.088

• Calculating of WACC :
Factor Weight Cost WACC

Common Stock 20% 17% 3.4%

Preferred Stock 20% 15% 3%

Bond 60% 8.8% 5.8%

Total 12.2%

• Calculating Proceeds from Old machine :

Selling Price 40000

Bookvalue (50000)

Capital Loss (10000)

20% Tax Shield 2000

Proceed = Selling Price + Tax shield = 12000

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• Calculating ii:
Machine 1 Machine 2

Purchasing Price 300000 250000

Shipping Cost 10000 20000

NWC 1000 5000

Proceed (12000) (12000)

ii 299000 263000

• Calculating Depreciation :

Dep. M1 = (Capital Cost - Salvage) / no. years = (310000 - 50000)/4 = 65000

Dep. M2 = (Capital Cost - Salvage) / no. years = (270000 - 40000)/4 = 57500

• Calculating Cash Flow :

1. Gross Profit of current machine

Year 1 Year 2 Year 3 Year 4
Sales 200000 240000 240000 230000
COGS 160000 192000 192000 168000
Gross Profit 40000 48000 48000 62000

2. Gross Profit of machine no.1

Year 1 Year 2 Year 3 Year 4
Sales 500000 450000 420000 400000
COGS 300000 270000 230000 220000
Gross Profit M1 200000 180000 190000 180000

3. Gross Profit of machine no.2

Year 1 Year 2 Year 3 Year 4
Sales 420000 450000 450000 430000
COGS 270000 290000 290000 250000
Gross Profit M2 150000 160000 160000 180000

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Calculating Cash Flow of M1

Year 1 Year 2 Year 3 Year 4

Gross Profit M1 200000 180000 190000 180000
Gross Profit 40000 48000 48000 62000
Incremental of Gross Profit 160000 132000 142000 118000
(Incremental Dep) (50000) (50000) (50000) (50000)
EBT 110000 82000 92000 68000
Tax 20% 22000 16400 18400 13600
NI 88000 65600 73600 54400
Incremental Dep 50000 50000 50000 50000
Salvage 50000
NWC 1000
CF M1 138000 115600 123600 155400

Calculating Cash Flow of M2

Year 1 Year 2 Year 3 Year 4

Gross Profit M2 150000 160000 160000 180000
Gross Profit 40000 48000 48000 62000
Incremental of Gross Profit 110000 112000 112000 118000
(Incremental Dep) (42500) (42500) (42500) (42500)
EBT 67500 69500 69500 75500
Tax 20% 13500 13900 13900 15100
NI 54000 55600 55600 60400
Incremental Dep 42500 42500 42500 42500
Salvage 40000
NWC 5000
CF M2 96500 98100 98100 147900

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Comparing the return of the two machines based on NPV

Machine 1 Machine 2

ii -299000 -263000

Year 1 138000 96500 Discount Rate 0.122

Year 2 115600 98100

Year 3 123600 98100

Year 4 155400 147900

NPV 101,385.66 63,710.93

According to NPV Criteria , It’s highly recommend to choose machine no.1 as

it has the higher NPV .

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