Computations
Old Machine
Replacement
Original Cost (OC)
50,000.00
125,000.00
Book Value
25,000.00
-
Salvage Value
60,000.00
-
Depreciation
5,000.00
-
Expected Life
10 years
5 years
Payback Period
OLD MACHINE
Year
Depreciation
Tax
Salvage Value
Net Cash Flow
1
(5,000.00)
(2,350.00)
60,000.00
52,650.00
2
(5,000.00)
(2,350.00)
-
(7,350.00)
3
(5,000.00)
(2,350.00)
-
(7,350.00)
4
(5,000.00)
(2,350.00)
-
(7,350.00)
5
(5,000.00)
(2,350.00)
-
(7,350.00)
TOTAL =
23,250.00
OC =
50,000.00
Payback =
0.95 year
REPLACEMENT
Depreciation
Tax
Investment Savings
Salvage Value
Net Cash Flow
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
TOTAL =
41,250.00
OC =
125,000.00
Payback =
n/a
Net Present Value
OLD MACHINE
Year
Depreciation
Tax
Salvage Value
Net Cash Flow
Rate (10%)
Preset Value
1
(5,000.00)
(2,350.00)
60,000.00
52,650.00
90.91%
47,863.64
2
(5,000.00)
(2,350.00)
-
(7,350.00)
82.64%
(6,074.38)
3
(5,000.00)
(2,350.00)
-
(7,350.00)
75.13%
(5,522.17)
4
(5,000.00)
(2,350.00)
-
(7,350.00)
68.30%
(5,020.15)
5
(5,000.00)
(2,350.00)
-
(7,350.00)
62.09%
(4,563.77)
TOTAL =
26,683.18
OC =
50,000.00
NPV =
(23,316.82)
REPLACEMENT
Depreciation
Tax
Investment Savings
Salvage Value
Net Cash Flow
Rate (10%)
Preset Value
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
90.91%
7,500.00
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
82.64%
6,818.18
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
75.13%
6,198.35
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
68.30%
5,634.86
(25,000.00)
(11,750.00)
45,000.00
-
8,250.00
62.09%
5,122.60
TOTAL =
31,273.98
OC =
125,000.00
NPV =
(93,726.02)
Profitability Index (PI)
Present Value of Cash Flows
Investment
PI
Old Machine
26,683.13
50,000.00
0.53
Replacement
31,273.98
125,000.00
0.25
Financial Leverage
Consistent with a rational market, individuals and other entities expect and are promised with higher (lower) returns if they engaged in investments with higher (lower) risks. Shareholders are concern with total risk because it is a measure of the risk of an exposure of business portfolio that is comprised by the sum of market and firm-specific risks. Due to this, investors can reduce their total risk through diversification without altering their expected return. However, this incentive is less attractive to contemporary investors because firm-specific risks are automatically considered when they hold a certain number of securities. As a result, firm specific risk becomes irrelevant to investment motivation because investors do not have to bear the firm-specific risk and therefore do not have to be compensated.
Operating Leverage
Cash flows are the lifeblood of a corporation and inability to maintain in a manageable level will lead bankruptcy. This admonition is supported by their study and found that cash flow is a more superior measure to predict bankruptcy than accrual accounting. As a result, for beneficial change in payment term, the company should keep separate cash and accrual records. This is especially significant as accounting policies are changed and the previously profitable companies that have substantial cash flows were tamed due to policy changes.
Cash conversion cycle or CCC is equal to the sum of average inventory days (AID) and average debtor days (ADD) less average creditor days (ACD). In the financial parlance, it represents the amount of time (e.g. days) in which the corporate cash is tied-up or freeze caused by the slack time between the payment of inputs for production and acceptance of end-user payment for the finish product. Within such slack time, the firm must have sufficient cash to keep day-to-day operations (e.g. converting inputs to outputs) otherwise it would halt operations or may lead to total shut down.
As an illustration, assuming that ABC Company has cost of sales totaling ,206 while AID, ADD and ACD are 62, 46 and 75 days respectively. In this case, CCC is equal to 33 days which means that the business must have sufficient funds available within this gap or it cannot continue to operate. The demanding component is that sufficient funds should be at least equal to 9 (,206/ 365 days)*33 days. This is where the importance of having minimal bad debts, stable bank balances, improved cash flow and manageable operational costs can be appreciated. For example, ABC Company can maintain stable bank balances to avoid charges or avail credit lines which undoubtedly a big help in times when CCC is too long. This is especially true at times of low product demand or productivity (high AID), piling of bad debts (high ADD) and demanding suppliers of either capital or raw materials (low ACD).
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