Question

2. 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.

1. Calculate the initial outlay of the project
2. Calculate the annual after-tax operating cash flow for Years 1 -4.
3. Determine the terminal year non-operating cash flow in year 4:
4. What is the equipment NPV?
5. What is the estimated Internal Rate of Return (IRR) of the equipment?
6. Should the equipment be accepted based on the IRR criterion?

Answer 1

ANSWER:

N 150 - : X fix =IRR(L44:L48) A B C D E 1 F G H I J K L M Cash flows Depreciati Depreciati from Working Total cash PVIF@ 43 Year Revenue Costs on PBT Tax@25% PAT on operations capital Investment flows | 8% | 0 $ (75,000) $(1,130,000) $(1,205,000)| 1.000 45 1 $ 600,000 $300,000 $376,629 $ (76,629) $ (19,157) $ (57,472) $376,629 $ 319,157 $ - $ 319,157 0.926 2 $ 600,000 $300,000 $502,285 $(202,285) $ (50,571) $ (151,714) $502,285 $ 350,571 $ - $ 350,571 0.857 3 $ 600,000 $300,000 $167,353 $ 132,647 $ 33,162 $ 99,485 $ 167,353 $ 266,838 $ $ 266,838 0.794 48 4 $ 600,000 $300,000 $ 83,733 $ 216,267 $ 54,067 $ 162,200 $ 83,733 $ 245,933 $ 75,000 $ 262,500 $ 583,433 0.735 =350000*(1-25%) -$1,205,000 IRR 9.08% 44 Present value $1,205,000.00 $295,515.97 $300,558.34 $211,824.81 $428,840.86 47 b) Net present value $31,739.98 $ 319,157 $ 350,571 $ 266,838 $ 245,933 54 55 $ 337,500 $31,739.98 9.08% Accept project

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