A domestic firm is considering a 8 -year project. The project requires an initia

Question

A domestic firm is considering a 8-year project. The project requires an initial acquisition cost of $2 mil and needs additional installation cost of $0.2 mil at the beginning of the project. You expect to sell the equipment at $25,000 at the end of the project. You plan to fully depreciate (Salvage value will be zero) the equipment using the straight line method for your project perod. In order to fund the project, you plan to issue 8 -year annual amortized $1 mil bond at 12%. The first year revenue is estimated to be $4 mil and expected to grow at a rate of 8% per year afterward. The first year COGS is estimated to be $2.5 mil and expected to grow at the same rate of 8 % per year afterward. Fixed cost of $1 mil is also expected each year. The NWC requirement is estimated at 8% of each year’s revenue and expected to recover all the remaining NWC at the end of the project. Tax rate is 40% and WACC is 15%.Determine whether you will accept or reject this project using NPV and IRR method.

Explanation / Answer

Working capital 8% of revenue Total Investment 1 320000 cash outflow 2000000 2 345600 Installation 200000 3 373248 2200000 4 403107.8 5 435356.5 Depreciation = 275000 6 470185 7 507799.8 8 548423.8 Total working capital 3403721 275000 total revenue variable cost contribution fixed cost Earning before Depreciation and tax Dep Casg flow after dep Interest cash flow after interest tax cash flow after tax dep cash flow before dep present value @15% present value of cash flow total revenue 8% contribution fixed cost Earning before Depreciation and tax Dep Casg flow after dep Interest cash flow after interest tax cash flow after tax dep cash flow before dep present value @15% present value of cash flow 1 4000000 2500000 1500000 100000 1400000 275000 1125000 120000 1005000 402000 603000 275000 878000 0.869565 763478.3 2 4320000 2700000 1620000 100000 1520000 275000 1245000 120000 1125000 450000 675000 275000 950000 0.756144 718336.5 3 4665600 2916000 1749600 100000 1649600 275000 1374600 120000 1254600 501840 752760 275000 1027760 0.657516 675768.9 4 5038848 3149280 1889568 100000 1789568 275000 1514568 120000 1394568 557827.2 836740.8 275000 1111741 0.571753 635641.4 5 5441956 3401222 2040733.4 100000 1940733 275000 1665733 120000 1545733 618293.38 927440.1 275000 1202440 0.497177 597825.2 6 5877312 3673320 2203992.1 100000 2103992 275000 1828992 120000 1708992 683596.85 1025395 275000 1300395 0.432328 562196.8 7 6347497 3967186 2380311.5 100000 2280311 275000 2005311 120000 1885311 754124.59 1131187 275000 1406187 0.375937 528637.7 8 6855297 4284561 2570736.4 100000 2470736 275000 2195736 120000 2075736 830294.56 1245442 275000 1520442 0.326902 497035.1 working capital investment 3403721 0.326 1109613 salvage value 25000 0.326 8150 present value of cash inflow 6096683 cash outflow 2200000 NPV @ 15% NPV of the Project 3896683 Rough Work N NPV of the project is positive so project should be accepted cash flow present value @ 50% 878000 0.6666667 585333.3 IRR = lower rate [lower rate NPv/lower rate npv - higher rate npv}difference in rates 950000 0.4444444 422222.2 IRR = 15 + [3896683/3996683 - (165212)]*35% 48.57% approx 1027760 0.2962963 304521.5 1111741 0.1975309 219603.1 1202440 0.1316872 158346 1300395 0.0877915 114163.6 1406187 0.0585277 82300.83 1520442 0.0390184 59325.27 3403721 0.0260123 88538.59 25000 0.0173415 433.5382 cash inflow 2034788 cash outflow 2200000 NPV at higher rate of 50% -165212

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