Holmes Manufacturing is considering a new machine that costs $200,000 and would

Question

Holmes Manufacturing is considering a new machine that costs $200,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $27,000 at the end of its 5-year operating life. The applicable depreciation rates are 33%, 45%, 15%, and 7%. Net operating working capital would increase by $24,000 initially, but it would be recovered at the end of the project's 5-year life. Holmes's marginal tax rate is 40%, and a 10% WACC is appropriate for the project.

A.)Calculate the project's NPV. Round your answer to the nearest cent.
$

Calculate the project's IRR. Round your answer to two decimal places.
%

Calculate the project's MIRR. Round your answer to two decimal places.
%

Calculate the project's payback. Round your answer to two decimal places.
years

B.)Assume management is unsure about the $90,000 cost savings-this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of these situations? Round your answers to the nearest cent. Negative amount should be indicated by a minus sign.

20% savings increase. $

20% savings decrease. $

C.)Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine's salvage value, and the net operating working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis:

Calculate the project's expected NPV, its standard deviation, and its coefficient of variation. Round your answers to two decimal places.

E(NPV) = $

?NPV = $

CV =

Would you recommend that the project be accepted? Yes or No

Scenario Probability Cost Savings Salvage Value NOWC Worst case 0.35 $72,000 $22,000 $29,000 Base case 0.35 90,000 27,000 24,000 Best case 0.30 108,000 32,000 19,000

Explanation / Answer

Solution :

First, we need to calculate the cash flow in each year and that is calculated and detailed explanation is provided below:

39600

Now we will calculate the net present value and the net present value is calculated by discounting the future cash flows at the expected rate.

IRR is the rate of return at which the net present value becomes zero.

Hence the IRR is the net present value becomes close to zero and the discounted rate at which the net present value becomes zero is 12,65%

c) The payback period would be :

-200000 +66000+75600+5600+45200 = 7600 at year 4 and hence the payback period is 4.2 years

Particulars year1 2 3 4 5 Save in cost 90000 90000 90000 90000 90000 Deprecitaion 33 % 45 % 15 % 7 % 0 % Depreciation expense 66000 90000 30000 14000 0 Increase in operating working capital 24000 24000 24000 24000 24000 profit before tax 0 -24000 36000 52000 66000 Tax rate @40% 0 -9600 14400 20800 26400 Profit after tax 0 -14400 21600 31200 39600 Cash flow = profit +depreciation 66000 75600 51600 45200

39600

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