Question

2. A project requires an initial investment of $100,000 and installation cost of $20,000. The financial manager of the company expects this project will cut the direct production costs by $30,000 per year. For tax purposes the project can be depreciated straight-line over 5 years. The company the machine. The salvage value of the machine is expected to be $15,000. If the company pays tax at a rate of 20% and the opportunity cost of capital is 20%, is the project attractive to the compeny? insurance expense of $5,000 per year beginning with the installation of will pay

Answer 1

	Opportunity cost	20%
Descp.	Dates	cashflow
Initial investment with charges	Jan-00	(120,000)
Cost saving + Insurance exp	Jan-00	25,000
Cost saving + Insurance exp	Jan-01	25,000
Cost saving + Insurance exp	Jan-02	25,000
Cost saving + Insurance exp	Jan-03	25,000
Cost saving + Insurance exp + Salvage value	Jan-04	40,000
	IRR	7.5%
	XNPV	(23,083.8)

If 20% is the opportunity cost is assumed then the IRR of the project is @ 7.5% which is significantly low,

Therefore, company should not be investing in this project

Note=all the formulas are used in excel to arrive at the number