Question 6.6: It is proposed to build a plant to produce a new product. Th...

The cash-flow calculations are summarised in Table 6.8. Sample calculations to illustrate the methods used are given below.

For year 4

Investment (negative cash flow) =£ 1.5 \times 10^{6}

Sales income =100 \times 10^{3} \times 150 =£ 15.0 \times 10^{6}

\text { Raw material costs }=100 \times 10^{3} \times 90 =£ 9.0 \times 10^{6}

Fixed operating costs =£ 0.4 \times 10^{6}

\text { Variable operating costs }=100 \times 10^{3} \times 10 =£ 1.0 \times 10^{6}

\text { Net cash flow }=\text { sales income }-\text { costs }-\text { investment } =15.0-10.4-1.5=3.1 \text { million pounds }

Discounted cash flow (at 15 per cent) =\frac{3.1}{(1+0.15)^{4}}=£ 1.77 \times 10^{6}

For year 8

Investment nil

\text { Sales income }=130 \times 10^{3} \times 150 =£ 19.5 \times 10^{6}

\text { Raw material costs }=130 \times 10^{3} \times 90 =£ 11.7 \times 10^{6}

Fixed operating costs =£ 0.4 \times 10^{6}

\text { Variable operating costs }=130 \times 10^{3} \times 10 =£ 1.3 \times 10^{6}

DCFRR

This is found by trial-and-error calculations. The present worth has been calculated at discount rates of 25, 35 and 37 per cent. From the results shown in Table 6.8 it will be seen that the rate to give zero present worth will be around 36 per cent. This is the discounted cash-flow rate of return for the project.