The following facts are presented on an opportunity to invest in Machine A: Cost
ID: 2383690 • Letter: T
Question
The following facts are presented on an opportunity to invest in Machine A: Cost of equipment is $200,000. The machine has an expected 4-year useful life; it will be depreciated according to the 3-year Modified Accelerated Cost Recovery System (MACRS). The estimated salvage value at the end of 4 years would be $20,000. The additional investment in working capital required would be $18,000. The applicable tax rate is 30 percent. The operating profits (excluding depreciation expenses) are estimated to be $80,000 per year for 4 years. The applicable cost of capital is 10 percent.
(a) Please calculate the NPV and IRR of the project.
(b) If the cost of new machine has increased to $235,000, what are the NPV and IRR of the project?
(Please show work)
Explanation / Answer
Answer to Q. No. A
Note 1: Initial cash outflow
Initial Cost of Equipment = $ 200,000
Working Capital = $18,000
Initial cash outflow = 200,000 + 18000 = $218,000
Note 2: Cash Inflow
Since Net profit is negative in Year 2, Cash Inflow is Net Loss and Tax Shied on Depreciation is carried forward to year 3
Depreciation calculation as per 3 Year MACRS
IRR is the discount rate where NPV is equal to Zero
Cash Outflow - PV of Cash Inflow = 0
= -218000 + 75998/(1+r) + 80000/(1+r)2+ 67556/(1+r)3+ 98446/(1+r)4 = 0
Solving above equation IRR (r) = 17.0254%
Answer to Q. No. B
Performing above Steps in similar way
NPV will be 8588.383
IRR will be 1.3749 %
Year 1 Year 2 Year 3 Year 4 Operating Profit 80000 80000 80000 80000 Less: Depreciation 66660 88900 29620 14820 Net profit 13340 -8900 50380 65180 Less : Taxes @ 30 % 4002 -2670 12444 19554 Net profit after Taxes 9338 -8900 37936 45626 Add: Depreciation 66660 88900 29620 14820 Cash Inflow 75998 80000 67556 60446 Add: Working Capital 18000 Add: Salvage value 20000 Net cash Inflow at the end of 4 Yr 98446Related Questions
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