PROJECT EVALUATION

Project Evaluation



Project Evaluation

Question 1

Calculate the initial investment, operating cash flows and the terminal cash flows for both Plant A and Plant B. Show all calculations.

Initial Investment

The investment to start a project, which includes all costs that have to be incurred in order to bring the project into functioning condition, is termed as “Initial Investment” (Fay, Rhoads, & Rosenblatt , 1971, pp 120 - 131).

Initial Investment - Project A

Land

$ 950,000

Buildings

$ 1,100,000

Machinery

$ 16,150,000

Furnishings and fittings

$ 345,900

Total Investment Cost

$ 18,545,900



Initial Investment - Project B

Land

$ 950,000

Buildings

$ 880,000

Machinery

$ 7,540,000

Furnishings and fittings

$ 810,000

Total Investment Cost

$ 10,180,000

Operating Cash Flows:

The cash flows generated by the utilization of the project are termed as “Operating Cash Flows”. These include all revenues generated less the operating expenses incurred to generate the cash (Balakrishnan, Sivaramakrishnan, Sprinkle, 2008, pp 80 - 8, 1).

Operating Cash Flows (5 Years) - Project A

Year 1 Sales in Units = 70,000Year 1 Selling Price =$ 35.00

Increase in Sales in Units =By 11 %Increase in Selling Price = By 3 %

Year

Sales in Units

Selling Price

Sales in Dollars

1

700,000

$ 35.00

$ 24,500,000

2

777,000

$ 36.05

$ 28,010,850

3

862,470

$ 37.13

$ 32,024,805

4

957,342

$ 38.25

$ 36,613,959

5

1,062,649

$ 39.39

$ 41,860,740



Variable Cost per Unit = $ 3.75

Labour Cost per Unit = $ 2.80

Total Variable Cost per Unit = $ 6.55

Operating Expense for Year 1 (700,000 x 6.55) = $ 4,585,000

Total Fixed Cost =$ 750,000

Total Operating Cost for Year 1 =$ 5,335,000

Year

Sales in Dollars

Sales in Units

Variable Costper Unit

Total Variable Cost

Fixed Cost

Tax Amount

Operating Cash Flow

1

$ 24,500,000

700,000

$ 6.55

$ 4,585,000

$ 750,000

$ 5,749,500

$ 13,415,500

2

$ 28,010,850

777,000

$ 6.75

$ 5,244,750

$ 750,000

$ 6,604,830

$ 15,411,270

3

$ 32,024,805

862,470

$ 6.95

$ 5,994,167

$ 750,000

$ 7,584,192

$ 17,696,447

4

$ 36,613,959

957,342

$ 7.16

$ 6,854,569

$ 750,000

$ 8,702,817

$ 20,306,573

5

$ 41,860,740

1,062,649

$ 7.37

$ 7,831,723

$ 750,000

$ 9,983,705

$ 23,295,312

Operating Cash Flows (5 Years) - Project B

Year 1 Sales in Units = 480,000

Increase in Sales in Units =By 11 %

Year 1 Selling Price =$ 40.00

Increase in Selling Price = By 3 %

Year

Sales in Units

Selling Price

Sales in Dollars

1

480,000

$ 40.00

$ 19,200,000

2

532,800

$ 41.20

$ 21,951,360

3

591,408

$ 42.44

$ 25,096,990

4

656,463

$ 43.71

$ 28,693,389

5

728,674

$ 45.02

$ 32,805,151

Variable Cost per Unit = $ 5.15

Labour Cost per Unit = $ 6.20

Total Variable Cost per Unit = $ 11.35

Operating Expense for Year 1 (480,000 x 11.35) = $ 5,448,000

Total Fixed Cost =$ 750,000

Total Operating Cost for Year 1 =$ 6,198,000

Year

Sales in Dollars

Sales in Units

Variable Costper Unit

Total Variable Cost

Fixed Cost

Tax Amount

Operating Cash Flow

1

$ 19,200,000

480,000

$ 11.35

$ 5,448,000

$ 750,000

$ 3,900,600

$ 9,101,400

2

$ 21,951,360

532,800

$ 11.69

$ 6,228,698

$ 750,000

$ 4,491,798

$ 10,480,863

3

$ 25,096,990

591,408

$ 12.04

$ 7,121,271

$ 750,000

$ 5,167,716

$ 12,058,003

4

$ 28,693,389

656,463

$ 12.40

$ 8,141,749

$ 750,000

$ 5,940,492

$ 13,861,148

5

$ 32,805,151

728,674

$ 12.77

$ 9,308,462

$ 750,000

$ 6,824,007

$ 15,922,683

Terminal Cash Flows

Terminal Cash Flows are the cash flows that are retrieved on the termination of a project. It includes all the amounts regarding the project termination like residual values, sale of equipments and other cash inflows (Balakrishnan, Sivaramakrishnan, Sprinkle, 2008, pp 80 ...