The $1.5m spent on the feasibility study are sunk costs and therefore not included in the analysis. Real growth of sales was calculated to be 1.5%. (5% nominal growth minus 3.5% Inflation). Straight-line depreciation is historical cost minus scrap value divided by useful life of the asset. Working capital is recovered every year. Weighted average cost of capital is preferred over the current market risk premium rate, due to the beta value having no relevance, as Burganz are comparing different proposals against an investment in the market. Net present value is calculated by the present value of the sum of net cash flows minus the initial cash outlay. The IRR is calculated at the point when the net present value of cash outflows (the cost of the investment) and cash inflows (returns on the investment) equal zero. Initial cash outlay was calculated by taking the cost of the facilities and adding back the salvage value of the old facilities and the depreciation tax savings. The depreciation tax savings returned to Burganz from the sale of the Adelaide factory is the initial cost of the factory ($10m) minus its current salvage value after 5 years ($4m) multiplied by the tax rate (34%). Income tax is net revenue multiplied by the tax rate (34%) Proposal one has no initial cash outlay, which results in an exceptionally large IRR, which is thus excluded, to avoid inaccurate decision making.
Conclusion
Proposal NPV IRR
1 $42,801,115.85 N/A
2 $58,218,587.29 99%
3 $62,690,783.78 86%
A comparison of the individual costs and revenues and incremental cash flows between all three proposals show that each proposal is acceptable under the NPV and IRR rules. However as the proposals are mutually exclusive, the preferred option for Burganz to adopt ...