A project will cost $4,819,724 and its expected to earn zero after one year, but

Question

A project will cost $4,819,724 and its expected to earn zero after one year, but $3,009,913 at the end of the second year, and $2,779, 333 at the end of the third year. Your company currently has borrowing worth $73,789,532 for which the company is paying 7.4% per year interest, and the owners of the company have invested a total of $149,815,110.40; and they generally want a return of 15% per year. Corporate tax rate is at 37%. Is this a good project or not? How many percent return/loss will your company have if you go ahead with the project?

Explanation / Answer

Evaluation of Project Year 0 Year 1 Year 2 Year 3 Initial cost $      (4,819,724.00) Expected earnings (Net of tax) $                     -   $       1,896,245.19 $       1,750,979.79 3009913*(1-0.37) 2779333*(1-0.37) Less : Interest cost (Net of tax) $ (227,731.96) $        (227,731.96) $        (227,731.96) 4819724*7.5%*(1-0.37) Net cash flows after tax (CFAT) $      (4,819,724.00) $ (227,731.96) $       1,668,513.23 $       1,523,247.83 PVF (15%)                       1.00000              0.86957                     0.75614                     0.65752 PV = CFAT *PVF $      (4,819,724.00) $ (198,027.79) $       1,261,635.71 $       1,001,560.17 NPV = Sum of PVs $      (2,754,555.90) we can see that the NPV of the project in negative, hence this project should not be accepted IRR of the project -28% using formula =IRR() IF the Co. go ahead with the project the loss shall be 28% IRR is negative 28% that is 15+28 = 43 % Less that required rate 15%

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