Gigi Buffon Manufacturing Company is considering a four-year investment project

Question

Gigi Buffon Manufacturing Company is considering a four-year investment project that involves the purchase of a new equipment that costs $600,000 today. The equipment will be depreciated on a straight-line basis over 4 years. The company expects the salvage value of the equipment will equal zero at the end of the year four. However, the company expects to sell the equipment at the end of fourth year to generate $20,000 after tax cash flow.

The purchase and utilization of the equipment will have an effect on the company’s net operating working capital (NOWC) at the beginning of the project. Specifically, the inventory will increase by $90,000, account receivable will increase by $50,000, and accounts payable will increase by $40,000. The investment on NOWC will be recovered at the end of the project.

The employment of the equipment is expected to increase sales of $1,000,000 in the first year, $1,200,000 in the second year $1,300,000 in the third year, and $1,400,000 in the fourth year. Each year the operating costs (excluding depreciation) are expected to equal 68.5 percent of the sales revenue. The company’s interest expense each year will be $125,560. The company’s overall WACC is estimated to be 13.75 percent and the company’s tax rate is 33 percent.

What are the NPV and MIRR of the project?

Explanation / Answer

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A B C D E Year 0 1 2 3 4 Cash Investment Net Working capital
= Increase in Inventory+increase in +increase in account receiables - account payable = 90,000 + 50000-40000 = 100,000 1 Initial Cost 600000 2 Net Working Capital 100000 3 Revenues 1000000 1200000 1300000 1400000 4 Operating costs 685000 822000 890500 959000 Operating Costs = 68.5% * Revenue 5 Depreciation 150000 150000 150000 150000 Depreciation =( Initial Cost-0)/4 6 Interest Expenses 125,560 125,560 125,560 125,560 7 EBT 39,440 102,440 133,940 165,440 EBT = Revenues - Operating cost- depreciation - interest 8 Tax = EBIT * Tax Rate 13015.2 33805.2 44200.2 54595.2 9 EAT = EBIT - Tax 26424.8 68634.8 89739.8 110844.8 10 Depreciation 150000 150000 150000 150000 11 After Tax Sale of equipment 0 0 0 20,000 12 Recovery of Net Working Capital 100000 13 Operating Cash Flow -700000 176424.80 218634.80 239739.80 380844.80 (EAT+Depreciation+After Tax Salvage Value) 14 Discount Rate 13.75% 15 NPV 14437.79 NPV(A14,B13:E13)+A13 For MIRR Operating Cash Flow -700000 176424.8 218634.8 239739.8 380844.8 MIRR =( Total Future Value of cash inflows/ PV of Cash outflow)^(1/4) -1 PV of Cash outflows 700000 Total FV of Cash outflows 259665.26 282892.93 272704.02 380844.8 1196107.02 FV = CASH FLOWS*(1+ R5)^(N-n) MIRR 14.33%

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