Case solution on United Metal

Calculation of Initial Outlay for new project:

NSV $ 1,725,000 Sensor cost 800,000
SV $ 500,000 Less NSV 1,725,000
BV $ 4,000,000 Tax 35% Add: Working Capital 319,231
IO=CF0 (605,769)

Incremental Depreciation Calculation:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
Depreciation with
production 1,125,000 843,750 632,813 474,609 355,957 266,968 200,226 150,169
Depreciation with 200000
purchasing 150,000 112,500 84,375 63,281 47,461 35,596 26,697
Incremental
Depreciation (925,000) (693,750) (520,313) (390,234) (292,676) (219,507) (164,630) (123,473)

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NPV calculation of Incremental cash flows:
Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
IO
(605,769)
Savings per year
700,000 700,000 700,000 700,000 700,000 700,000 700,000 700,000
Savings from salary
of vacant position (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)

Net savings before

depreciation 600,000 600,000 600,000 600,000 600,000 600,000 600,000 600,000

Less Depreciation
(925,000) (693,750) (520,313) (390,234) (292,676) (219,507) (164,630) (123,473)
Before tax
1,525,000 1,293,750 1,120,313 990,234 892,676 819,507 764,630 723,473
Less Tax (35%)
533,750 452,813 392,109 346,582 312,437 286,827 267,621 253,215
After tax
991,250 840,938 728,203 643,652 580,239 532,679 497,010 470,257
Add Back
Depreciation (925,000) (693,750) (520,313) (390,234) (292,676) (219,507) (164,630) (123,473)

Project Operating Growt

Cash flow 66,250 147,188 207,891 253,418 287,563 313,173 332,379 346,785 h rate
2,167,404 4%
CFs
(605,769) 66,250 147,188 207,891 253,418 287,563 313,173 332,379 2,514,189
NPV 576,749
IRR 38%
Cut Off Rate 20%
Note: Growth rate is calculated based on year 7 & 8’s Cash flows. Thus the terminal value is calculated by using Gordon Growth Model
amounting Taka 25,14,189.
Decision: Based on above calculation of Incremental cash flows The Net Present Value (at 20% discount Rate) is Taka 156691. So, the purchasing
manager was correct and that's why United Metal should go for purchasing the component rather than producing and go for a renewable
contract with the Amalgamated Components as this modification and contract decision will actually create a good amount of wealth for United
Metal.

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