Question

A Zambian manufacturing company is considering investing in a machinery of 6.5 million kwacha to produce a soft drink with a market life of four years . The production variable cost is 6 kwacha per unit and other variable cost 2 kwacha per unit. The annual incremental fixed cost is 1.65 million kwacha. The scrap value of the machinery is estimated to be 3 million kwacha after tax at the end of year 4 . The company expects to produce and sell 300000 units per year. The estimated selling price is 25 kwacha per unit. The selling price and variable expenses are expected to increase annually by 8% and 6% respectively starting from the second year. The project minimum expected rate of return by investor is 12% whereas the average industrial cost of capital is 10% corporate tax 30%. Calculate NPV and IRR

Answer 1

To calculate the NPV and IRR, calculate the cash flows for each year and apply the appropriate formulae.

To calculate the Net Present Value (NPV) and Internal Rate of Return (IRR) for the investment in the machinery, we need to calculate the cash flows for each year of the project and apply the appropriate formulae. The NPV is the sum of the present values of all cash flows, while the IRR is the discount rate that results in an NPV of zero. Here are the steps:

1. Calculate the annual cash flows by subtracting the variable costs from the selling price and multiplying by the expected units produced and sold.
2. Calculate the annual present value of each cash flow using the discount rate of 12% and including the tax rate of 30% for the scrap value at the end of year 4.
3. Sum up the present values of all cash flows to calculate the NPV.
4. Calculate the IRR by iteratively trying different discount rates until finding the rate that results in an NPV of zero.

By following these steps, you can determine the NPV and IRR for the investment in the machinery.