Incremental Cash Flows Essay
1- Calculate the changes in revenues by finding sales revenue for both machines for ten years and subtract the old from the new for each year.
2- Calculate the changes in costs by subtracting the operating costs of old from the new and add them to the material, labor, general and administrative costs. (We have to calculate the material, labor, general and administrative costs although it remains constant because the $10 is per unit and unit changes year-by-year for each machines)
3- Calculate the depreciation for old and new machine and subtract the old from the new.
4- Calculate EBIT for each year by subtracting change in costs and depreciation from changes in revenues.
5- Calculate the taxes for each year by multiplying 35% with the EBIT for each year.
6- Calculate the Net Income by subtracting Taxes from …show more content…
Because sunk costs are the costs that have already been incurred and it is not possible that they can change in the future. Incidental costs are also irrelevant because these are the costs that are also called business travel expenses.
They include the meals, accommodation costs etc. during a trip and they have nothing to do with the new investment. Incremental cash flow is relevant in the context of this case.
3- We can use scenario analysis. In this approach we consider the best, worst and the base case to calculate the NPV. The best case refers to high revenues and low costs and the worst case is the opposite. If the NPV varies volatile in this three case, we should think twice. For example if the NPV falls below zero in one of the cases then we should take the rejection into consideration also. Moreover, we can also conduct sensitivity analysis, which helps us understand the changes in NPV when we vary one variable at a time.
4- When calculating the initial investment, we should consider the cost ot the new machine , after tax proceeds from the sale of old machine, increase in NWC.