Your team have just been assigned to a major project in its capital budgeting division. This assignment requires your team to determine the net cash flows and Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period of a proposed new manufacturing machinery that will allow your organisation to produce new age electric vehicles of different types. It is anticipated, that if adopted, this new project will displace sales for a range of petrol run vehicles over the next decade. It is also expected that these petrol vehicles will be slowly phased down and production eliminated by the end of this 10-year period. There is also expected to be changes in both net working capital and depreciation rates. The government has also legislated subsidies to manufacturers and buyers of electric cars. They also intend to fund major infrastructure to support a major rollout of these cars. Demand for electric cars is expected to increase substantially and peak by the end of 15 years.

As part of this assignment, your team is provided with substantial financial information that will allow you to determine the expected cash flows from this project over the next 15 years. Please note the following information that will allow you to complete the required financial tasks:

Table 1. The initial costs of the project

Cost of the equipment	$600,000,000
Commissioning and transportation costs	$60,0000,000
Extensions to existing manufacturing facilities	$40,000,000
Extensive training for engineering and other staff	$20,000,000

Note 1. Please note that $10,000,000 has been spent on consultants and other advisors as part of the initial investigations in relation to the manufacture of electric cars.

Note 2.Further capital injections will be required to update, modify and maintain the equipment over the next 15 years. The capital expenditure is as follows:

Year 3	Year 6	Year 9	Year 12
$25,000,000	$35,000,000	$45,000,000	$55,000,000

Note 3. There is an expectation that the equipment will be sold and replaced after 15 years. The sale price is anticipated to be 20% of the total initial cost and other capital expenditure occurred over the course of the equipment's useful life. Any profit or loss on sale of this machinery will be subject to Australian capital gains tax law where all gains are taxed at the corporate tax rate and any losses will generate a tax saving.

In addition to the capital expenditure the project will require the company to invest in net working capital. The projected cash flows relating to working capital are listed in table 2.

Table 2. Projected working capital expenditures

Years	Cash flow
0	$10,000,000
1	$15,000,000
2	$20,000,000
3	$25,000,000
4-15	$20,000,000

Projected Sales Information - New Project

The new project in electric cars is expected to generate $80,000,000 in sales in the first year. This sales figure is then expected to grow at an annual rate of 10% for the next 5 years and then at 20% until the end of year 15. However, this new project will displace sales from existing petrol motor vehicle sales for the next 10 years as follows:

Table 3. Lost Sales from Petrol base motor vehicles

Year	Lost Sales ($)
1	$10,000,000
2	$13,000,000
3	$16,000,000
4	$18,000,000
5	$20,000,000
6	$22,000,000
7	$26,000,000
8	$24,000,000
9	$22,000,000
10	$18,000,000

Projected Cost Information - New project

The operating costs for the new project are expected to be $10,000,000 (not including depreciation costs) in year 1 and then increasing at a rate of 10% per year until the end of 15 years. Overhead costs are also expected to increase by a further $5,000,000 per year as a direct result of this project. These additional overhead costs are expected to increase by 5% per year for the next 15 years. Due to the lost sales in the petrol run vehicles, it is expected that there will be reduction in some of the operating costs relating to these vehicles. They cost savings will be as follows:

Table 4. Reduction in costs - Petrol base motor vehicles

Year	Lost Sales ($)
1	$3,000,000
2	$4,000,000
3	$5,000,000
4	$7,000,000
5	$9,000,000
6	$12,000,000
7	$14,000,000
8	$12,000,000
9	$11,000,000
10	$9,000,000

Note: These figures include depreciation costs.

Depreciation on new Machinery

The new machinery will be subject to accelerated depreciation for tax purposes and this will also be applied to accounting operating profit calculations. The capitalised costs of the new machinery will be depreciated at a rate of 30% (diminishing value) per year. Any new capital costs will be added to the book value of the machinery in the year it is incurred.

Financing the project

Please note the company intend to borrow an initial amount of $700,000,000 to meet the financing requirements of this new machinery. They have projected an annual interest cost of $38,000,000 per year for the next 15 years.

Cost of capital

The following information has been provided to you in relation to the firm's capital: The firm's cost of debt have an average cost of 5% before tax. Recent data indicates that the company's beta is 1.2 and the market risk premium is estimated to be 6%. The percentage of debt utilised by the company is 50% and equity makes up the other 50%. The company uses the WACC to discount the expected incremental cash flows from potential capital projects.

Other relevant information

The company is subject to a 30% tax rate. A payback period of 6 years is required on this project.

Objectives:

1. You are required to calculate (in Excel) all the incremental after-tax cash flows for the new project. You will need to state in your supporting report all the assumptions you have made around the cash flows you have either disregarded or included in the calculations.

Answer rating: 100% (QA)

To calculate the incremental aftertax cash flows for the new project well need to consider various f... View the full answer