Question

Cosmo Plant Engineering Limited is planned to purchase a machine for $1,480,000. It has an estimated life of 6 years. It is estimated that the machine's operating and maintenance cost is amounted to $8,500 per year and a part-time operator will be employed at a wage of $66,000 in the first year. The inflation for operating and maintenance cost and staff cost escalation is 8% p.a. and 10% p.a. respectively. Cosmo is expected to generate profit by producing 120,000 Product X per year in the first 3 years, 140,500 in the 4th \& 5th year and 100,000 in the 6th year. The selling price and raw material cost for each product is $15.5 and $5.6 respectively. The machine has a scrap value of $120,000 at the end of the 6th year.

(a) Prepare a table to show the cash flow structure of the project.
(b) Calculate the Net Present Value (NPV) of the project if the cost of capital at 8%.
(c) Based on your calculation, suggest if this is a good investment.

Answer 1

To prepare a table showing the cash flow structure of the project, consider the costs and revenues for each year. Calculate the Net Present Value (NPV) of the project using a cost of capital of 8% and determine if it is a good investment.

Step-by-step explanation:

To prepare a table showing the cash flow structure of the project, we need to consider the costs and revenues for each year. The costs include the purchase cost of the machine, operating and maintenance costs, and the part-time operator's wage. The revenues include the profit generated from the sale of Product X. Here is an example of how the table can be structured:

YearCostsRevenues1$1,480,000 + $8,500 + $66,000 = $1,554,500$15.5 x 120,000 - $5.6 x 120,000 = $816,0002$8,500 + $66,000$15.5 x 120,000 - $5.6 x 120,000 = $816,0003$8,500 + $66,000$15.5 x 120,000 - $5.6 x 120,000 = $816,0004$8,500 + $66,000$15.5 x 140,500 - $5.6 x 140,500 = $964,1005$8,500 + $66,000$15.5 x 140,500 - $5.6 x 140,500 = $964,1006$8,500 + $66,000$15.5 x 100,000 - $5.6 x 100,000 = $594,000 + $120,000 (scrap value)

To calculate the Net Present Value (NPV) of the project, we need to discount the cash flows to their present value. We can use the formula:

NPV = (Revenues - Costs) / (1 + r)^t

Where r is the cost of capital and t is the year. Using a cost of capital of 8%, we can find the present value of each cash flow and sum them up to get the NPV. If the NPV is positive, it is considered a good investment.

Based on your calculation, you can determine if this is a good investment by analyzing the NPV. If the NPV is positive, it means that the present value of the cash inflows is greater than the present value of the cash outflows, indicating a profitable investment. However, if the NPV is negative, it means that the present value of the cash outflows is greater than the present value of the cash inflows, indicating a loss-making investment.