Question

Based on the increasing theft rate in Sunset Harbor, the Harbor is planning to upgrade its security system. It is a 4 year-period project and will significantly increase Sunset Harbor’s security level. The financial data is as follows: • Investment: $45,000 o 50% debt-equity ratio. Loan ($22,500) borrowed at 6% interest. • Project life: 4 years • Salvage value: $8,000 o Year 0 dollars • Depreciation method: 3-year MACRS • Income tax rate: 25% • Annual Saving: $28,000 o Year 0 dollars • Annual Expense: $14,000 o Year 0 dollars o Does NOT include depreciation o Does NOT include interest • Market interest rate ( i ): 7% If the general inflation rate (effects revenues, expenses, salvage value) during the next 4 years is expected to be 2% annually: a. Develop the income statement for the project. b. Develop the cash flow statement for the project. (Hint: Don’t forget the Financing Activities) c. Determine the PW of the project. Is the project economically viable? Why?(Hint: Cash flows in Actual dollars, given market interest rate. Therefore, no need to convert to constant dollars before calculating PW)

Answer 1

	0	1	2	3	4
Cost of Project	45000
Equity	22500
Debt	22500
Savings (Year1=Year0*1.02)	28000	28560	29131.2	29713.82	30308.10048
Expense (Year1=Year0*1.02)	14000	14280	14565.6	14856.91	15154.05024
Depreciation (Year1:33.33%;Year2:44.45%;Year3:14.81%;Year4:7.41%)		14998.5	20002.5	6664.5	3334.5
PBIT		-718.5	-5436.9	8192.412	11819.55024
Interest	1350	1350	1350	1350	1350
PBT		-2068.5	-6786.9	6842.412	10469.55024
Tax		0	0	1710.603	2617.38756
PAT		-2068.5	-6786.9	5131.809	7852.16268
OFCF		14280	14565.6	14856.91	15154.05024
Salvage Value (Year1=Year0*0.98)	8000	7840	7683.2	7529.536	7378.94528
Casflow from Financing Activities
Inflow	45000
Outflow		-45000			-22500
Cashflow from Investing Activities	0	0	0	0	0
Casflow from Operations
Inflow		12930	13215.6	11796.31	11186.66268
Cash at beginning of Period		0	12930	26145.6	37941.909
Cash at end of period		12930	26145.6	37941.91	49128.57168
Salvage Value					7378.94528
Net cash at End					34007.51696
NPV		₹ -11,801.17
Casflows		-45000+12930	=13215.6	=11796.31	=11186.66-22500+7378.945
=		-32070	13215.6	11796.31	-3934.395
Discounted cashflows at 7%		-29971.96262	11543.02	9629.302	-3001.531108
NPV (Sum of above)=	-11801.2
As NPV is -ve, the project should not be accepted