BUS5111 – Financial Management

Written Assignment – Week 3

Instructor: Dominic Isaac

Submitted by: Syed Zeeshan ulHassan.

The WePROMOTE Company has finalized its estimates and is now tasked with conducting a

Net Present Value (NPV) analysis for their upcoming project of providing phone covers to

customers. The NPV method enables businesses to comprehensively evaluate the impact of the

time value of money on an initial investment. However, the considerations of depreciation and

taxes are crucial in determining the overall feasibility and profitability of the proposed capital

investment. These factors significantly affect a company's cash flow and must be considered

when performing an NPV analysis. Neglecting to properly assess these factors can lead to

drastically different decisions compared to when they are properly evaluated, potentially posing

a threat to the business's sustainability and profitability. Nevertheless, as businesses strive to

grow and expand, significant capital expenditures become inevitable. WePROMOTE's endeavor

to develop unique smartphone cases will require such investments. Therefore, a thorough NPV

analysis is imperative, taking into consideration not only cash inflows and outflows but also the

impact of taxes and depreciation on these cash flows, ultimately guiding the decision to proceed

with or abandon this project.

The research approach involves calculating various financial metrics including before-tax net

cash flows, depreciation, income before taxes, taxes, discount rates, present values, total present

values, and ultimately, the net present value for the company. Below is a detailed description of

the method along with the formulas required to obtain the results. The method is presented in

Table 1, which will be referred to throughout the discussion.

 Year
1 2 3 4 5
30,0 30,0 30,0 30,0 30,0
Revenue inflows
00 00 00 00 00
(11,0 (11,0 (11,0 (11,0 (11,0
Costs outflows -
00) 00) 00) 00) 00)
19,0 19,0 19,0 19,0 19,0
Before-tax net cash flows
00 00 00 00 00
(14,0 (14,0 (14,0 (14,0 (14,0
Depreciation -
00) 00) 00) 00) 00)
5,0 5,0 5,0 5, 5,
Income before taxes
00 00 00 000 000
(1,5 (1,5 (1,5 (1,5 (1,5
Taxes @ 30% -
00) 00) 00) 00) 00)
3,5 3,5 3,5 3, 3,
After-tax net income
00 00 00 500 500
14,0 14,0 14,0 14,0 14,0
Depreciation +
00 00 00 00 00
17,5 17,5 17,5 17,5 17,5
After-tax cash flows
00 00 00 00 00
After-tax salvage value +
- - - - -
After-tax total net cash 17,5 17,5 17,5 17,5 17,5
flows 00 00 00 00 00
Discount rate @ 6% x 0.9434 0.8900 0.8396 0.7921 0.7473
16,509. 15,575. 14,693. 13,861. 13,077.
Present value of cash flows
50 00 00 75 75
Net Present Value
73,717

Throughout the equipment's lifespan, WePROMOTE expects annual revenue flows of $30,000,

with consistent cost outflows of $11,000. Considering these inflows and outflows, the net cash

flows before taxes amount to $19,000 for each of the first five years. Since depreciation is a non-

cash expense that is tax-deductible, $14,000 is subtracted from the net cash flow before taxes,

resulting in $5,000, which represents income before taxes are applied (Obaidullah, 2014).

WePROMOTE utilizes the straight-line depreciation method, calculated using the formula 1/n

(where n represents the life of the equipment) multiplied by the depreciable asset cost. In this

instance, the calculation is 1/5 * $70,000 (since there is no salvage value deducted), resulting in

$14,000 per year in depreciation charges.

As required by law, companies must pay income tax on their net income. Given a tax rate of 30%

and an income of $5,000, WePROMOTE anticipates paying $1,500 in taxes to the government

((30 * $5,000) / 100). This leaves an after-tax net income of $3,500. Subsequently, the non-cash

depreciation is added back to the after-tax net income, resulting in an after-tax cash flow of

$17,500.

WePROMOTE's after-tax total net cash flows remain at $17,500 since there is no salvage value

at the end of the equipment's life.

The Discounted Cash Flow (DCF) method is utilized to bring future cash flows to their present

values, providing a firm with insight into the investment's value. According to Chen (2019), if

the future value of the investment exceeds its cost, it is deemed a viable endeavor.

WePROMOTE requires a minimum return of 6% for investments, indicating the lowest

acceptable rate for considering the investment profitable compared to other options.

The formula CF / (1+r)^n is employed, where CF represents cash flow, r denotes the discount

rate, and n signifies the number of future periods for which the cash flow will be discounted.

After factoring in the estimated tax and depreciation-affected cash flows, the total present value

amounts to $73,717. This implies that an investment of $70,000 by WePROMOTE now would

yield $73,717 in the future, resulting in a Net Present Value (NPV) of $3,717.

Depreciation, the decline in value of an asset over its useful life, does not directly affect cash

outflow. However, it does influence the tax liability of a corporation. This is because

depreciation expenses are tax-deductible, meaning they reduce taxable income without affecting
net income. Consequently, depreciation deductions lower the amount of taxes owed since they

decrease taxable income (Turner, 2013). As a result, businesses receive a tax advantage through

depreciation deductions, leading to reduced tax payments. Since taxes are levied on a company's

net profits, both revenues (cash inflows) and expenses (cash outflows) have a significant impact

on tax liability.

Indeed, the significance lies in the fact that these inflows and outflows directly affect the

company's net income or profits (Heisinger & Hoyle, 2012). Consequently, the business needs to

compute the after-tax cash flow and settle the corresponding tax obligation accordingly.

Based on the detailed analysis provided in the preceding narratives and tabular computations, it

is recommended that WePROMOTE move forward with the project. The positive Net Present

Value (NPV) of $3,717 indicates that the future profits are positive in present terms (Sanjay,

2019). This suggests that investing in this project aligns with the best interests of the company.

In conclusion, effective decision-making regarding capital investment is essential for the

longevity and stability of firms. Growth and profit expansion are fundamental objectives for

companies and employing tools like Net Present Value (NPV) analysis can provide invaluable

insights into investment options. However, it's crucial to acknowledge the substantial impact of

depreciation and taxes on NPV, necessitating their careful consideration in the analysis process.

Nonetheless, NPV remains a dependable and accurate approach, offering findings that can guide

capital planning decisions with confidence.

 References

Chen, J. (2019). Understanding Discounted Cash Flow. Retrieved from

http://www.investopedia.com/terms/d/dcf.asp

Heisinger, K., & Hoyle, J.B. (2012). Accounting for Managers. Saylor Foundation. Retrieved

from

https://resources.saylor.org/wwwresources/archived/site/textbooks/Managerial

%20Accounting.pdf

Obaidullah, J. (2014). NPV and Taxes. Retrieved from

https://xplaind.com/633736/npv-and-taxes December 2 2019

Parker, J. (2019). How Does Depreciation Affect Cash Flow? Retrieved from

http://www.investopedia.com/ask/answers/080216/how-does-depreciation-affect-cashflow.asp

Sanjay, B. (2019). Capital Budgeting – 5 Investment Appraisal techniques. Retrieved from

https://efinancemanagement.com/investment-decisions/capitalbudgeting

Tuner, J. A. (2013). Net Operating Working Capital Budgeting and Cash Budgets: A Teaching

Example.

American Journal of Business, 6(6), 641-648. Retrieved from

https://files.eric.ed.gov/fulltext/EJ1088192