Chapter 8: Relevant cash flows for DCF

Part 1. A new machine will cost $120,000 and is expected to last 3 years with no scrap value. Production will be 10,000 units a year. The selling price is $20 per unit and the variable production cost $14 per unit, both quoted in current prices. Inflation is expected to be 5% a year, and the cost of capital is 15% a year.

Part 2. Tembo plc is considering buying a new machine for $2,800,000 to make a new product. The machine will last 3 years and then have a scrap value of $1,000,000. Tembo expects to make and sell 100,000 units a year, sold at $20 per unit in the first year. Production costs per unit at current prices are materials $8 and labour $7. Materials are expected to inflate at 8% a year and labour at 5% a year. The company's fixed overheads are currently $1,000,000 a year, and the management accountant has decided that 20% of them should be absorbed into the new product. The selling price is expected to rise by 7% a year. An additional $200,000 of working capital is needed at the start of the project. Capital allowances: 25% reducing balance. Tax: 25%, one year in arrears. Cost of capital: 10%.

Sign convention: inflows positive, outflows negative. Part 2 figures are entered in $000.