What is the present worth of this investment? (b) Compare the IRR of this projec

ID: 2526592 • Letter: W

Question

What is the present worth of this investment?

(b) Compare the IRR of this project with that of a situation of no working capital.

What is the IRR of the project with working capital?

What is the IRR of the project with no working capital?

The Newport Company is planning to expand its current spindle product line. The required machinery would cost $620,000. The building that will house the new production facility would cost $1.9 million. The land would cost $440,000, and $340,000 working capital would be required The product is expected to result in additional sales of $805,000 per year for 10 years, at which time the land can be sold for $780,000, the building for $1,000,000, and the equipment for $100,000. All of the working capital will be recovered. The annual disbursements for labor, materials, and all other expenses are estimated to be $495,000. The firm's income tax rate is 40%, and any capital gains will be taxed at 35%. The building will be depreciated according to a 39-year property class. The manufacturing facility will be classified as a seven-year MACRS. The firm's MARR is known to be 11% after taxes Click the icon to view the MACRS depreciation schedules for personal property. Click the icon to view the MACRS percentages for nonresidential real property. Click the icon to view the interest factors for discrete compounding when i= 11% per year. (a) Determine the projected net after-tax cash flows from this investment. Fill in the table below. (Round to two decimal places.)

Explanation / Answer

Initial Investment:

Machinery Cost = $620,000
Building Cost = $1,900,000
Land Cost = $440,000
Working Capital = $340,000
Total Outlay = $3,300,000

Depreciation of Machinery

Year

Basis

Depreciation Expense

Accumulated Depreciation

Ending Book Value

$620,000.00

14.29%

$88,573.20

$531,426.80

$620,000.00

24.49%

$151,838.00

$240,411.20

$379,588.80

$620,000.00

17.49%

$108,456.60

$348,867.80

$271,132.20

$620,000.00

12.50%

$77,469.00

$426,336.80

$193,663.20

$620,000.00

8.93%

$55,335.00

$481,671.80

$138,328.20

$620,000.00

8.93%

$55,335.00

$537,006.80

$82,993.20

$620,000.00

8.93%

$55,335.00

$592,341.80

$27,658.20

$620,000.00

4.46%

$27,664.40

$620,006.20

-$6.20

Depreciation of Building

Year

Basis

Depreciation Expense

Accumulated Depreciation

Ending Book Value

$1,900,000.00

2.46%

$46,688.70

$1,853,311.30

$1,900,000.00

2.56%

$48,717.90

$95,406.60

$1,804,593.40

$1,900,000.00

2.56%

$48,717.90

$144,124.50

$1,755,875.50

$1,900,000.00

2.56%

$48,717.90

$192,842.40

$1,707,157.60

$1,900,000.00

2.56%

$48,717.90

$241,560.30

$1,658,439.70

$1,900,000.00

2.56%

$48,717.90

$290,278.20

$1,609,721.80

$1,900,000.00

2.56%

$48,717.90

$338,996.10

$1,561,003.90

$1,900,000.00

2.56%

$48,717.90

$387,714.00

$1,512,286.00

$1,900,000.00

2.56%

$48,717.90

$436,431.90

$1,463,568.10

$1,900,000.00

2.56%

$48,717.90

$485,149.80

$1,414,850.20

Capital gain on sale of Land at the end of project = $780,000 - $440,000 = $340,000
Capital loss on sale of Building at the end of project = $1,414,850.20 - $1,000,000 = $414,850.20
Capital gain on sale of machinery at the end of project = $100,000

Net gain/loss = $340,000 + $100,000 - $414,850.20 = $25,150

Since there is a net capital gain on disposal of assets upon end of project, there would be a tax levied on the gain.

Tax on gain = $25,150*35% = $8,802.43

After-tax salvage value of project = $780,000 + $1,000,000 + $100,000 - $8,802.43 = $1,871,197.57

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

Year 10

Sales

$805,000.00

Less: Cost

$495,000.00

Less: Depreciation on Machinery

$88,573.20

$151,838.00

$108,456.60

$77,469.00

$55,335.00

$27,664.40

$0.00

Less: Depreciation on Building

$46,688.70

$48,717.90

EBT

$174,738.10

$109,444.10

$152,825.50

$183,813.10

$205,947.10

$233,617.70

$261,282.10

Less: Tax @ 40%

$69,895.24

$43,777.64

$61,130.20

$73,525.24

$82,378.84

$93,447.08

$104,512.84

Net Profit

$104,842.86

$65,666.46

$91,695.30

$110,287.86

$123,568.26

$140,170.62

$156,769.26

Add: Depreciation of Machinery

$88,573.20

$151,838.00

$108,456.60

$77,469.00

$55,335.00

$27,664.40

$0.00

Add: Depreciation of Building

$46,688.70

$48,717.90

Add: Recovery of Working Capital

$0.00

$340,000.00

Add: After-tax Salvage Value

$0.00

$1,871,197.57

After-tax Cash Flow

$240,104.76

$266,222.36

$248,869.80

$236,474.76

$227,621.16

$216,552.92

$205,487.16

$2,416,684.73

Formula for NPW: -Initial investment + [(Cash Inflow1)/(1+r)1] + [(Cash Inflow2)/(1+r)2] + [(Cash Inflow3)/(1+r)3]…..+ [(Cash Inflown)/(1+r)n]

Net Present Worth:
-$3,300,000 + ($240,104.76/1.11) + ($266,222.36/1.112) + ($248,869.80/1.113) + ($236,474.76/1.114) + ($227,621.16/1.115) + ($227,621.16/1.116) + ($227,621.16/1.117) + ($216,552.92/1.118) + ($205,487.16/1.119) + ($2,416,684.73/1.1110) = $2,161,957.55

So, the Net Present Worth of the project is $2,161,957.55

IRR with Working Capital

0 = -$3,300,000 + ($240,104.76/1+IRR) + ($266,222.36/1+IRR2) + ($248,869.80/1+IRR3) + ($236,474.76/1+IRR4) + ($227,621.16/1+IRR5) + ($227,621.16/1+IRR6) + ($227,621.16/1+IRR7) + ($216,552.92/1+IRR8) + ($205,487.16/1+IRR9) + ($2,416,684.73/1+IRR10)

IRR = 4.33%

IRR without Working Capital

In the absence of working capital requirements, the initial investment would drop by $340,000 and last year’s after-tax cash flow would also drop in same quantum.

0 = -$2,960,000 + ($240,104.76/1+IRR) + ($266,222.36/1+IRR2) + ($248,869.80/1+IRR3) + ($236,474.76/1+IRR4) + ($227,621.16/1+IRR5) + ($227,621.16/1+IRR6) + ($227,621.16/1+IRR7) + ($216,552.92/1+IRR8) + ($205,487.16/1+IRR9) + ($2,076,684.73/1+IRR10)

IRR = 4.92%

Depreciation of Machinery

Year

Basis

Depreciation Expense

Accumulated Depreciation

Ending Book Value

$620,000.00

14.29%

$88,573.20

$531,426.80

$620,000.00

24.49%

$151,838.00

$240,411.20

$379,588.80

$620,000.00

17.49%

$108,456.60

$348,867.80

$271,132.20

$620,000.00

12.50%

$77,469.00

$426,336.80

$193,663.20

$620,000.00

8.93%

$55,335.00

$481,671.80

$138,328.20

$620,000.00

8.93%

$55,335.00

$537,006.80

$82,993.20

$620,000.00

8.93%

$55,335.00

$592,341.80

$27,658.20

$620,000.00

4.46%

$27,664.40

$620,006.20

-$6.20

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