Name : Irfan Poonawala Id # 82210015

Homework on Relevant Cash Flow Calculations

Question 1:

A.
T=0 T=1 T=2 T=3 T=4 T=5
1 Cash Flow $(110,000) $30,000 $30,000 $30,000 $30,000 $30,000

2 Discount Rate 10%

3 NPV $3,723

Since NPV is positive – Firm can consider replacing the old machine

B. Yes - Replace the machine. Since Depreciation is non cash item and the new machine
is giving annual saving of $30,000 for which the NPV is ~ $ 3,723 over next 5 years.

C.
T=0 T=1 T=2 T=3 T=4 T=5
1 Cash Flow $(150,000) $40,000 $40,000 $40,000 $40,000 $40,000
2 Discount Rate 10%
3 NPV $ 1,631

Firm should buy the new machine since NPV of the new machine is positive and the old
machine as mentioned is obsolete

D. Yes, in the hindsight, one would say that buying the machine two years ago was a
mistake. However, at that point of time it was the correct decision since it had
positive NPV.

Relevant Cash Flows Problem 1

Name : Irfan Poonawala Id # 82210015

Question 2:
Items (in thousands of dollars) T=0 T=1 to 4 T=5
1 Revenues 12,000 12,000
2 Raw Material Costs 4,000 4,000
3 Direct costs 1,000 1,000
4 Depreciation 4,000 4,000
5 EBIT (1-2-3-4) 3,000 3,000
6 Tax Rate 40% of 5 1,200 1,200
7 NOPAT (5-6) 1,800 1,800
8 Increase in Inventories -400 0 400
9 Capital Expenditures -20,000 0 0
10 Cash Flow of Project (7+4+8+9) -20,400 5,800 6,200
11 NPV of line 10 @11% $1,274

A:
A/P = raw material cost*36/365 = 4000*36/365 = 395
A/R = revenue * 50/365 = 12,000*(50/365) = 1644
Free Cash Flow (FCF) = A/P – A/R = (1249)
PVAF of FCF = (1249) * 0.31 = (385)
Incremental NPV = 1,274 + (385) = 889

B.
No. This should not be included since it is fixed cost (sunk cost) and hence not to be
included for cash flow

C.
Finance charges are not to be included since they are not part of incremental cash flows.
They are already part of discounting factor and hence including them would imply double
counting

Relevant Cash Flows Problem 2

Name : Irfan Poonawala Id # 82210015

Question 3:

A. Impact of cannibalization needs to be considered since it has negative impact on

the NPV. Impact of $ -650,000*3.696 = -2,402,400

B. The opportunity cost of $100,000 needs to be considered for NPV calculation.

Considering 5 years period, there is negative impact on NPV by 100,000*3.696=
(369,600)

C. Marketing cost if it is paid in the past before the start of the project, then it needs to be
excluded. This is a sunk cost and hence to be excluded from NPV calculation

Relevant Cash Flows Problem 3