Question

Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses of $300,000. An inventory investment of $75,000 is required during the life of the project. Read Book Company is in the 25 percent tax bracket, and its existing cost of capital is 8 percent.

A. Calculate the initial outlay of the project.

B. Calculate the annual after-tax operating cash flow for Years 1 -4.

C. Determine the terminal year (in year 4) after-tax non-operating cash flow.

D. What is the equipment’s NPV?

E. What is the estimated Internal Rate of Return (IRR) of the project?

F. Should the project be accepted based on the IRR criterion?

Answer 1

ANSWER

a): Initial outlay= -1,205,000

b):

Year	OCF
1	319157.25
2	350571.25
3	266838.25
4	245933.25

c): Terminal non operating CF = 337500

d):

NPV	$31,739.98

e):

IRR

9.08%

f): Yes, since it is higher than WACC.

Workings

operating cash flows

Year	Cash flows	Depreciation	EBIT	Tax	PAT	OCF
1	300000	-376629	-76629	19157	-57471.75	319157.25
2	300000	-502285	-202285	50571	-151713.75	350571.25
3	300000	-167353	132647	-33162	99485.25	266838.25
4	300000	-83733	216267	-54067	162200.25	245933.25

Net Cash flows

Year	Initial cash flow	OCF	Working capital	Salvage	Net cash flows
0	-1130000		-75000		-1205000
1		$319,157.25			319157.25
2		$350,571.25			350571.25
3		$266,838.25			266838.25
4		$245,933.25	75000	262500	583433.25

Calculations

Book1- Excel AutoSave e ff O Tell me what you wai File Insert Formulas Review View Help Home Draw Page Layout Data X А А Calibri 8 General Conditional Format as Paste В I U A Formatting Table Clipboard Font Alignment Number Styles fox Initial cost A2 A В C D E F G Н 1 INPUTS Initial cost 3 -850000+280000 Year Initial cash flow OCF Working capital Salvage -B5 Net cash flows -SUM(D3:G3) Tax rate 0 -B2 0.25 4 Selling price 5 Working capital 75000 6 MARR 7 -SUM(D4:G4) -SUM(D5:G5) -SUM(D6:G6) -B4* ( 1 - B3 )=SUM(D7:G7) 350000 117 2. =l 18 0.08 1 19 Annual cash flow -600000-300000 4 120 --F3 10 11 12 13 14 =IRR(H3:H7) IRR NPV(B6,H4: H10) +H3 NPV 15 Year 16 1 17 2 18 3 19 4 MACRS 3 year DepreciationEBIT =$D$3*B16 -SD$3*B17 -$D$3*B18 Depreciation rate OCF Year Cash flows =SB$7 =SB$7 =SB$7 0.3333 PAT -SUM(D17:E17)-F17*$B$3-F17+G17 -SUM(D18:E18)F18*$B$3=F18+G18 =SUM (D19: E19)-F19*SB$3 -F19+G19 Таx OCF 0.4445 H17-E17 -H18- E18 0.1481 -H19-E19 3 -$B$7 0.0741 20 5 21 6 $D$3*B19 =SUM(D20:E20)-F20*$B$3 -F20+G20 H20-E20 22 23 Sheet1 Sheet2 Sheet3 Ready е х‑ O

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