a private company based in Kitwe. The company is considering investing into a project that will be producing belts to be sold to the mining companies. The project will demand that the company buys a special equipment that costs K800,000 from South Africa to replace the old machine which have a book value of K100,000. The old machine has one year of economic life with expected scrap value of zero. The equipment have expected useful life of 5 years with K120,000 scrap value. Jonken uses straight line method of depreciation to depreciate its Non-Current Assets and claims tax allowances at 25% per year reducing balance. Installations costs of K100,000 will also be incurred before the project starts but will be paid for next year when the equipment starts operating.
The belts are expected to cost the company K16 each to take to the market and will be sold for K24 each. It is estimated that the cost per belt will be increasing by 5% compounded each year and selling price by 6% compounded each year.
The company expects to sell 90 000 units in the first year,rising to 120 000 in year 2, and 80 000 in year 3, before rising back to 120 000 for each of years 4 and 5.
At the beginning of the project, it is expected that there will be K40 000 of inventory required. At the same time accounts receivables will be K50 000 and accounts payable of K25 000. The net working capital will be maintained at 3% of total sales revenue per year until the end of the project.
To sell the projected units, the company will need to advertise and the advertising costs are estimated at K40,000 in the first year and followed by K45,000 per year thereafter.
The company faces a tax rate of 30%.Tax is paid one year in arrears. The cost of capital is expected to remain at 11%.
Required:
a. Calculate the initial investment outlay of the project (3 Marks)
b. Calculate the terminal cash flow for the project. (2 marks)
c.Lay out the relevant cash flows for the project (15 Marks)
d. Calculate Net Present Value (NPV) for the project and advise on its acceptability