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Cost cutting proposals
- 1. Cost cuttingproposals Most companiesface the decisiontomake existingfacilitiescosteffective . So theymustverifythatthe cost savingislargerthan the capital expenditure theyare taking Example Suppose ABCcompanydecidedtoautomate partof itsbusiness.The new equipmentcost$80,000 but it will save $22,000per year before taxes. The equipmenthasa5 year depreciationstraightlineandwill be worthatthe endof the periodfor $20,000 .Tax is 34% and discountrate is 10% cost 80,000 EBDIT 22,000 years 5 discountrate 10% Taxes 34% depreciation striaghtline sellingprice 20,000 depreciationcalculation 16000 Gain fromthe sellingmachine 20,000 tax 6800 EBDIT 22,000 cash receivedinthe 5thyear 13,200 Depreciation 16000 EBT 6,000 tax 2040 netincome 3,960 depreciation 16000 OCF 19,960 year 0 1 2 3 4 5 5 operatingcashflow 19,960 19,960 19,960 19,960 19,960 13,200 netspending -80,000 0 NWC 0 0 0 0 0 0 0 Total cash flowof the firm -80,000 19,960 19,960 19,960 19,960 33,160 0 PV of cash @10% $18,145.45 $16,495.87 $14,996.24 $13,632.95 $20,589.75 NPV $3,860.27 Example 2
- 2. cost newmachine 730,000 cost saving(EBDIT) 270,000 DepreciationMACRS5 Years 4 bookvalue @year4 126,144 endof year4 value 70,000 sellingprice 70,000 NWC year0 20,000 loss -56,144 change NWC yearly 3,500 tax saving= 19650.4 tax 35% cash receivedinyear4 89,650 Discountrate 8% Year 0 1 2 3 4 EBDIT 270,000 270,000 270,000 270,000 depreciation 146,000 233,600 140,160 84,096 EBIT 124,000 36,400 129,840 185,904 Taxes 43400 12740 45444 65066.4 NI 80,600 23,660 84,396 120,838 depreciation 146000 233600 140160 84096 OCF 226,600 257,260 224,556 204,934 Cash flowwof the firm OCF 226,600 257,260 224,556 204,934 NetSpending - 730,000 Change inNWC -20,000 -3500 -3500 -3500 30,500 Terminal value 89,650 - 750,000 total cash flow - 750,000 223,100 253,760 221,056 325,084 pv@8% $838,560.20 $88,560.20
- 3. Depreciaiontable MACRS5Yeats 20% 32% 19.20% 11.52% 11.52% 5.76% 146000 233600 140160 84096 84096 42048
- 4. Settingthe bidprice What doesthismean It meansyournet presentvalue of the projectyouare biddingwillalwaysbe ZERO Example # of trucks yearly 5 #of years 4 cost of each truck 10,000 lease yearly 24,000 laborand material 4000 yearlycost 94000 NWC 40,000 Depreciation straightline capital spending 60,000 bookvalue zero value of equipafter5 years 5,000 gain gain 5,000 tax 39% tax 1950 DiscountRate 20% cash received year5 3,050 Value of 0 1 2 3 4 OCF ($30,609.17) ($30,609.17) ($30,609.17) ($30,609.17) NWC -40,000 40,000 Capital spending -60,000 3050 43,050 20761 npv (100,000)+ocf for 4 yearsat 20%+43050 -56,950 0 ocf-56950=0 OCF without discounting 79239.00463 pv for1$ $2.59 OCF discounted $30,609.17 NI sales 134,589 peryear 26917.7592 pertruck cost 94,000 depreciation 15,000 so yourbidprice must not be lessthen27,000 EBIT 25588.79578 tax $9,979.63 NI $15,609.17 Depreciation 15000 OCF $30,609.17
- 5. OCF=(sales-VC-fixedcost)(1-tax )+depreciation*tax 30,609.17=sales-94,000)*(1-.39)+15,000*.39 30,609.17-5859+57340=.61(sales) 82090/.61=143,589= Sales Question32 page 202 Q 15,000 newequipmentcost 3,400,000 depreciation SL bookvalue 0 #of years 4 NWC 75,000 sellingprice atthe endof the project 200,000 fixedcost 700,000 variable cost 105 NPV 100,000 tax 40% Discountrate 13% international sales price sale 205 1 2 3 4 quantity 4000 12,000 14,000 7000 sales 820000 2460000 2870000 1435000 variable cost 420000 1260000 1470000 735000 EBT 400000 1200000 1400000 700000 tax 160000 480000 560000 280000 NI 240,000 720,000 840,000 420,000 pv 212389.31 563865.61 582162.13 257593.86 1616010.9 NPV =- Initial investment+ocf international +ocf (pv13%4years)+terminal value 100,000=-3,475,000+1616011+ocf+(120,000+75,000)/1.13^4 0cf =$1,839,391.85 / PVIFA13%,4= $618,392.87 Sales VC 1575,000 Fixedcost 700,000 Depreciation 850,000 EBIT 1648987
- 6. taxes 659595 NI 989392 depreciation 850,000 OCF 1,839,392