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Clearaway Upholstery: calculate investment alternatives for cash flows

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QUESTION - CLEARAWAY UPHOLSTERY LIMITED

a) Calculate the initial investment associated with each alternative.

b) Calculate the incremental operating net cash inflows associated with each alternative.

c) Calculate the terminal cash flow at the end of five years associated with each alternative.

d) Make a recommendation presenting the most favourable option to Clearaway Upholstery Limited.

SEE ATTACHED FILE FOR FULL DETAIL's OF CASE AND ANSWER THE ABOVE FOUR QUESTIONS

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Solution Summary

The solution analyzes the two alternatives, shows the calculations and arrives at a conclusion about which alternative is preferred.

Solution Preview

Please refer to the attachment.

This question involves estimating the cash flows over the life of the project and applying several capital budgeting techniques to evaluate the project.

Show all calculations and workings outs of each alternative 1 and 2 and give explanation of method used - (if possible show / present this within MS Excel).

COMPLETED ANSWERS
QUESTION - CLEARAWAY UPHOLSTERY LIMITED
Jason Humphries, chief financial officer of Clearaway Upholstery Limited, expects the firm's net profits after taxes for the next five years to be as shown in the following table:
Year Net profits after taxes
1
2
3
4
5 $100,000
$150,000
$200,000
$250,000
$320,000

Jason is developing the relevant cash flow calculations needed to analyse whether to renew or replace Clearaway's only depreciable asset, a machine originally costing $30,000, having a current book value of $0, and that can be sold for $20,000. [Note: Because the firm's only depreciable asset is fully depreciated - its book value is zero - its expected net profits after taxes equal its operating net cash inflows.] Estimates are that at the end of five years the existing machine can be sold to net $2000 before taxes. The company tax rate is 30%. The company uses the straight-line depreciation method. Two alternatives are being considered and are independently outlined ...

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