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Case Study : If the Coat Fits, Wear It

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Cash Flow Table

The following cash flow table which is divided into three main sections: initial investment which shows all cash flows at the beginning of replacement, annual operating cash flows which indicate the effect of enter the new machine and eliminate the old machine. And finally terminal year cash flows which prove the effect of sell new and old machine and their tax shields. All the calculations which provided the amount of cash flows in this table are available in appendix.

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Initial Net Working Capital

An initial increase in account receivable, that is $54000 plus increase in inventory which is $20000 is equal to $74000, if the increase in account payable minus from it the total amount would be $44000 that is called initial working capital that comes to year 0 cash flow tables as a negative amount because this is cash outflow. Although according to the case would be recovered at the end of the period which is 5 years in this case as cash inflow.

Tax is not involved with working capital because it is a change in form of assets. Gitman, Juchau- Flanagan, 2008, p. 357-358). Change in net working capital 10% of each year new machine revenues negatively, without participating tax, plus previous year revenue would be net working capital for new machine. For example year 1 revenue for new machine is $3960000 which 10% of it is $396000 minus year zero working capital which is $44000 which is equal to $352000 is called year one working capital and in year 5 sum of all working capital from year0 to year5 has been recovered.

For the old machine is opposite positive amount from 10% of revenue minus previous year revenue put in the cash flow table.

Interest Expense

An annual interest expense is the item that does not has to be included into cash flow table for calculating NPV, IRR and PI. This kind of expense is the finance cost and has been used to calculate weighted average cost of capital which is 20% in this case. Furthermore the amount of loan $300000 must not be get involved in the table because it was used to calculate WACC as well.

After calculate the cash flow for the entire table 10% of $300000 which is $30000 and after tax with the following formula (1-0. 3) the amount of interest would be $21000. According to the case the company must pay in advance therefore it be added from year0 to year 4 and add up with previous cash flows and use just for calculate payback period. (Kasempa, week 6, tutorial handout) 2-5. Inflation rate There are two methods for involving inflation rate in the calculation. One of them is to be adapted cash flows with the following formula: NPV=-CF0+ t=1nCFt(1+inf? t(1+i)t and another solution is adjusting the discount rate which is used in this case. : i=1+0. 21+0. 03-1 =0. 165048.

All the cash flows in the table have not been adjusted with inflation instead “i” would be 16. 5048 in all calculation. (Lee, week5, lecture note) 2-6 Payback Periods Based on payback period analysis in the table below the company should not replace the machine because according to company payback period that is 3 years but the payback period for this replacement is 4. 16 years.

Cite this Case Study : If the Coat Fits, Wear It

Case Study : If the Coat Fits, Wear It. (2016, Nov 12). Retrieved from https://graduateway.com/case-study-if-the-coat-fits-wear-it/

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