QUESTION
The J. F. Manning Metal Company is considering the purchase of a new milling machine during year zero.
The machine’s base price is €P, and it will cost another 12% €P to modify the machine for special use by
the company, resulting in a 112%€P cost base for depreciation.
The cost base will be financed by a 60% loan of the cost-base from a commercial bank for five-years at an
interest rate of 4% remaining constant over the loan life. The rest will be financed by company’s own
funds.
The machine falls into the ten-year straight-line method with a zero-salvage value at year ten. The
machine can be sold after five years at 35%€P (actual euros).
Use of the machine will require an increase in working capital (inventory) of 6% €P at the beginning of the
project year.
The machine will have no effect on revenues, but it is expected to save the company 60%€P (today’s
euros) per year in before-tax operating costs ~ mainly labour.
The company’s marginal tax rate is 23%, and this rate is expected to remain unchanged over the projects
duration. However, the company expects that the labour cost will increase at an annual rate of L% and
that the working capital requirement will grow at an annual rate of C% caused by inflation.
The general inflation rate (f) is estimated to be 6% per year over the project period. The company’s MARR
is 20% (Market interest rate).
a. What are the depreciation allowances of this project? [10 marks]
b. What is the gains tax (if any) for this project? [15 marks]
c. Develop the loan schedule of this project. [20 marks]
d. Determine the project cash flows in actual euros. [35 marks]
e. Is this project acceptable? [10 marks]
f. What is the project’s IRR? [10 marks]
PS.
€P L% C%
€135,000 5% 8%
bP fi
i- Market interest rate
i – Inflation — free interest rate
(f— Inflation rate
*SOLVE USING MICROSOFT EXCEL
