Suppose a firm is considering an investment of $300,000 in an asset with a usefu

Question

Suppose a firm is considering an investment of $300,000 in an asset with a useful life of 5 years. The firm estimates that the annual cash revenues and expenses will be $140,000 and $40,000, respectively. The annual depreciation based on historical cost will be $60,000. The required rate of return on a project of this risk is 13%. The marginal tax rate is 34%.

a. What is the IRR and the NPV of this project?

b. The 13% required return is a nominal required return including inflation. Suppose the firm has forgotten that revenues and expenses are likely to increase with inflation at a 5% annual rate. Inflate the revenues and expenses at 5% per year and recalculate the NPV. Is this a more attractive proposal now that inflation has been taken into account?

Explanation / Answer

a. Cash Flow =(140000-40000)*(1-34%)+(60000*34%) Year Cash Flow 0 ($300,000) 1 $86,400 2 $86,400 3 $86,400 4 $86,400 5 $86,400 IRR, using excel formula 13.53% NPV, using excel formula $3,889 b. Cash Flow =(140000-40000)*(1-34%)*1.05+(60000*34%) Year Cash Flow 0 ($300,000) 1 $89,700 2 $89,700 3 $89,700 4 $89,700 5 $89,700 IRR, using excel formula 15.10% NPV, using excel formula $15,496 Yes, it’s a more attractive proposal now that inflation has been taken into account

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.