Holmes Manufacturing is considering a new machine that costs $240,000 and would
ID: 2655317 • Letter: H
Question
Holmes Manufacturing is considering a new machine that costs $240,000 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 $25,000 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 $22,000 initially, but it would be recovered at the end of the project's 5-year life. Holmes' marginal tax rate is 40%, and a 13% WACC is appropriate for the project.
Calculate the project's NPV. Round your answer to the nearest cent.
$ 23,981.36
Calculate the project's IRR. Round your answer to two decimal places.
16.80%
Calculate the project's MIRR. Round your answer to two decimal places.
15.00%
Calculate the project's payback. Round your answer to two decimal places.
3.18 years
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.
20% savings increase. $ 61,967
20% savings decrease. $
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?
Explanation / Answer
Worst-case scenario:
0 1 2 3 4 5
Initial investment ($250,000)
Net oper. WC (30,000)
Cost savings $72,000 $ 72,000 $72,000 $72,000 $72,000
Depreciation 82,500 112,500 37,500 17,500 0
Oper. inc. before taxes ($10,500) ($ 40,500) $34,500 $54,500 $72,000
Taxes (40%) (4,200) (16,200) 13,800 21,800 28,800
Oper. Inc. (AT) ($ 6,300) ($ 24,300) $20,700 $32,700 $43,200
Add: Depreciationa 82,500 112,500 37,500 17,500 0
Oper. CF $76,200 $ 88,200 $58,200 $50,200 $43,200
Return of NOWC $30,000
Sale of Machine 18,000
Tax on sale (40%) (7,200)
Net cash flow ($280,000) $76,200 $ 88,200 $58,200 $50,200 $84,000
NPV = -$7,663.52
Base-case scenario:
This was worked out in part a. NPV = $37,035.13.
Best-case scenario:
0 1 2 3 4 5
Initial investment ($250,000)
Net oper. WC (20,000)
Cost savings $108,000 $108,000 $108,000 $108,000 $108,000
Depreciation 82,500 112,500 37,500 17,500 0
Oper. inc. before taxes $ 25,500 ($ 4,500) $ 70,500 $ 90,500 $108,000
Taxes (40%) 10,200 (1,800) 28,200 36,200 43,200
Oper. Inc. (AT) $ 15,300 ($ 2,700) $ 42,300 $ 54,300 $ 64,800
Add: Depreciationa 82,500 112,500 37,500 17,500 0
Oper. CF $ 97,800 $109,800 $ 79,800 $ 71,800 $ 64,800
Return of NOWC $ 20,000
Sale of Machine 28,000
Tax on sale (40%) (11,200)
Net cash flow ($270,000) $ 97,800 $109,800 $ 79,800 $ 71,800 $101,600
NPV = $81,733.79
Prob. NPV Prob. ´ NPV
Worst-case 0.35 ($ 7,663.52) ($ 2,682.23)
Base-case 0.35 37,035.13 12,962.30
Best-case 0.30 81,733.79 24,520.14
E(NPV) $34,800.21
sNPV = [(0.35)(-$7,663.52 – $34,800.21)2 + (0.35)($37,035.13 – $34,800.21)2 + (0.30)($81,733.79 – $34,800.21)2]½
= [$631,108,927.93 + $1,748,203.59 + $660,828,279.49]½
= $35,967. 84.
CV = $35,967.84/$34,800.21 = 1.03.
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