FINANCE QUESTIONS AND ANSWERS ASSIGNMENT SOLUTION

QUESTION 1

1. RECOMMENDATION:

The NPV is the capital budgeting technique that calculates the present value of net cash inflows that are generated by the project including its salvage value less the initial investment on the project. Since the NPV for the new machine is given to be -$ (24,076,710) and the NPV of old machine is given to be -$(10,805,263), so it seems to stick with old machine as it will cost less for the company. Although the new machine is saving 50% of the labor cost, still the incremental costs are more as compared to the benefits it might bring. 

1. DIFFERENCES AND CHOICE:

The cost of new machine is $13,271,447 more than the old machine cost over next three years. This means that by installing new machine, the company will incur $13,271,447 extra cost given the rate of 9% WACC. It is recommended to the company to carry on with the older machinery as the NPV of cost is much lower for the older machine as compared to new machine. 

Part B)

1. WACC increased by 1%

New NPV of Old Machine: 

New NPV of New Machine

The NPV of new machine has fallen from $10,805,263 to $10,612,130 and the NPV of old machine has fallen to $23,840,333 from $24,076,710. This is because WACC is the rate that is used by the firms to discount the cash flows to find NPV. Both NPV and WACC are found to be inversely related, any increase in WACC will cause a reduction in NPV. This is because a higher interest rate means the company will have to set aside less today for earning a specified amount in future. With higher WACC, the projected cash flows will be discounted today at a higher rate, thus reducing the overall net present value and vice versa. 

2. Base Rate Entity

If the firm enters into base rate entity, its tax rates are set to reduce to 27.5% for year 2019-2020. However, for the current scenario, the tax rate is already set at 27.5%, hence no changes will incur today. However, for 2020-21 and 2021-22 the tax rates will be 26.0% and 25.0%. Hence, following are the new NPVs on given new rates. Both NPVs have fallen with decrease in tax rates. 

New NPV of Old Machine

New NPV of New Machine

3. Increase in Salary

With the increase in salaries by 5% annually, the NPV has risen for both the machines from $10,805,263 and $24,076,710 to $10,934,965 and $24,273,016 respectively. This is because the operational costs have risen and more cost is incurring in future to be discounted at 9%.