Question

17) Delta Inc. is considering the purchase of a new machine which is expected to increase sales by $10,000 in addition to increasing cash expenses by $3,000 annually. Due to the sales increase, Delta will need to increase working capital by $2,000 at the beginning of the project. This working capital investment will not be recouped in the final year of the project. Delta will depreciate the machine using the straight-line method over the project's five-year life to a salvage value of $2,000. The machine's purchase price is $20,000. The firm has a marginal tax rate of 21%. Delta's required rate of return for such projects is 12%. [NOTE: You must show all of your work for each of the below questions to receive full credit.] a) [2 pts] What is the total initial investment for this project? b) [2 pts] What is the project's incremental after-tax cash flow in year 1? c) [2 pts] What is the project's incremental after-tax cash flow in year 5? d) [1 pt] If the calculated IRR for this project is 15%, should Delta accept this project? Why - please explain your answer.

Answer 1

a. Initial investment = $22,000
b. Incremental cash flow at year 1 = $6286
c. Incremental cash flow at year 5 = $9866
d. IRR: It is the discount rate at which the present value of projects cash outflows (cost) is equal to the present value of projects cash inflow.

The IRR(15%) must be above the cost of capital/required rate of return(12%) because the project generates more return than required rate of return.

Project must be accepted.