Relevant cash flows Present- value discount factors at 14% Total present value 1 Initial investment in CIM today 2a Current disposal price of old production line 2b Current recovery of working capital (€6 − €2) 3 Recurring operating cash savings
€4* each year for 10 years 4a Higher terminal disposal price of machines (€14 − €0) in year 10 4b Reduced recovery of working capital (€2 − €6) in year 10 Net present value of CIM investment €(45) 5 4 4 14 (4) 1.000 1.000 1.000 5.216 0.270 0.270 €(45.000) 5.000 4.000 20.864 3.780 (1.080) €(12.436) * Recurring operating cash flows areas follows Cost of maintaining software programs and CIM equipment €(1.5) Reduction in lease payments due to reduced floor-space requirements 1.0 Fewer product defects and reduced reworking 4.5 Annual recurring operating cash flows €4.0 On the basis of this formal financial analysis, Dinamica should not invest in CIM – it has a negative net present value of €(12.436) million. 2 Requirement 1 only looked at cost savings to justify the investment in CIM. Manuel estimates additional cash revenues net of cash operating costs of €3 million a year as a result of higher quality and faster production resulting from CIM. From Appendix B, Table 4, the net present value of the €3 million annuity stream for 10 years discounted at 14% is €3 × 5.216 = €15.648. Taking these revenue benefits into account, the net present value of the CIM investment is €3.212 (€15.648 − €12.436) million. On the basis of this financial analysis, Dinamica should invest in CIM. 3 Let the annual cash flow from additional revenues be €X. Then we want the present value of this cash flow stream to overcome the negative NPV of €(12.436) calculated in requirement 1. Hence, X (5.216) = 12.436 X = €2.384 million An annuity stream of €2.384 million for 10 years discounted at 14% gives an NPV of €2.384 × 5.216 = 12.436 (rounded.