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KADS, Inc. has spent RM300,000 on research to develop a new computer game. The firm is...

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Finance

KADS, Inc. has spent RM300,000 on research to developa new computer game. The firm is planning to spend RM250,000 on amachine to produce the new game.

Shipping and installation costs of the machine will be capitalizedand depreciated; they total RM50,000.

The machine has an expected life of 3 years, a RM175,000 estimatedresale value, and depreciation is estimated at RM35,725 for 1styear, RM61,225 for 2nd year and RM43,725 for 3rd year.

Revenue from the new game is expected to be RM500,000 per year,with costs of RM250,000 per year.

It is expected that the machine needs a major maintenance in secondyear of operation at a cost of RM200,000.

The firm has a tax rate of 35 percent, an opportunity cost ofcapital of 15 percent, and it expects net working capital (in termof advance payment for machine licence) to increase by RM100,000 atthe beginning of the project and will be fully recaptured at theend of the project.
What will the cash flows for this project be? Should KADS undertakethis project? Why?

Answer & Explanation Solved by verified expert
4.0 Ratings (481 Votes)

Year 0 1 2 3
Revenue 500000.00 500000.00 500000.00
Less: Costs 250000.00 250000.00 250000.00
Less: maintenance 200000.00
Less: Depreciation 35725.00 61225.00 43725.00
PBT 214275.00 -11225.00 206275.00
Tax @ 35% 74996.25 -3928.75 72196.25
PAT 139278.75 -7296.25 134078.75
Add: depreciation 35725.00 61225.00 43725.00
Less: costs of machine 250000
Less: shipping and installation 50000
Add: resale value 175000
Less: taxes @ 35% 5486.25
Less: working capital 100000 -100000
Net Cash Flow -400000 175003.75 53928.75 447317.5
NPV @ 15% 87,073.57
Resale 175000
Book value
Investment 400000
Less: depreciation 140675
Book value 259325
Tax @ 35% -29513.75
Since NPV is positive the project should be undertaken. Also the R&D costs is ignored as it is a sunk cost

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