Incremental variable cost for year one and same, yet adjusted for inflation for year two to year five.
Incremental cost associated with automation for year one and same, yet adjusted for inflation for year two to year five.
Adjusted rework costs by 80% of current for year one to year five, adjusted for 2% inflation annual adjustment.
Incremental depreciation cost for year one to year five. No inflation adjustments.
Incremental tax deducted at 28% on incremental EBIT .Reasons:
The above costs are future-oriented.
All are not sunk costs.
Tied directly to the evaluation of the expansion program.
Time value of those cash flows can be respectively computed.
Concentrate on the difference approach.
Compute the incremental cash flows in respect to both projects. As opposed to total cost of each approach. Errors are likely to occur, where total profit approach is applied, reasons:
Total profit approach is cumbersome and tiresome.
It does not integrate the aspect of time value of money.
Total profit aspect is ambiguous, it has no clear interpretation since profit may be inflated hence misleading.
Differential cash flow approach uses cash flow as opposed to the other approach which is based on profit streams.
Exhibit 1.0 attached excel, with a series of sheets. Workings are integrated respectively.
The other methods evaluation of expansion proposal, such as IRR and payback period result to a contradicting deduction relative to NPV method and Profitability Index technique. They do not preferably give Favorable insight per se.
Initial multiyear cash requirement:
i) It increases consequential interest and financing cost
Unfavorable pressure on cash flow
A favorable tax shield
It will increase the cost of capital beyond 9.5%
Increase the chances of insolvency in the company
ii) Implication will be difference since the company would consider stand-alone project cash flows and not incremental cash flows, therefore the implications would be different inter alia.
Extract of Washwares report for directors
Recommendation: Adopt the proposal
Exhibit 1.0 above has analytical evaluation of the proposed program based on NPV technique. Considering the general rule of this technique a project of positive NPV should be adopted since it is financially viable. Other Techniques of project evaluation analysis such as payback period, IRR, have also been analyzed and the recommended option deducted. However other methods save for PI and NPV have serious short false such as ignorance of time value of money, this explains the preferences of NPV technique deduction and analysis.
Dlabay, L. R., & Burrow, J. (2008). Business finance. Mason, Ohio: South Western
Institute of Chartered Accountants in England and Wales. (2000). Finance & management. London (Chartered Accountants' Hall, PO Box 433, Moorgate Place, London EC2P 2BJ: Faculty of Finance and Management, The Institute of Chartered Accountants in England and Wales.
Noguchi *, M. (2005). Interaction between tax and accounting practice: Accounting for stock-in-trade. Accounting, Business & Financial History, 15(1), 1-34. http://dx.doi.org/10.1080/09585200500032701Performance Measurement Association. (2005). Journal of accounting, finance & management strategy. Fort Lauderdale, FL: PMA Pub.
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