LEE Corporation intends to purchase equipment for $1,500,000. The equipment has
ID: 2665926 • Letter: L
Question
LEE Corporation intends to purchase equipment for $1,500,000. The equipment has a 5-year useful life and will be depreciated on a straight-line basis. Addition of the equipment requires additional working capital of $20,000. The $20,000 is expected to be recaptured at the end of the project. LEE’s marginal tax rate is 40%. Use of the equipment is expected to change the company’s reported EBIT by $600,000 in year one, $700,000 in year two, $550,000 in year three, $200,000 in year four, and $100,000 in year five. Due to changing market conditions, the equipment did have a salvage value of $100,000 at the end of year five.please show how to calculate free cash flow years 1-4, initial outlay, terminal cash flow, internal rate of return and the net present value if the risk-adjusted discount rate is 20%.
Explanation / Answer
Initial outlay
Initial outlay
Cost of the asset
1500000
Additional working capital
20000
Total Initial Outlay
$1,520,000
Calculation of depreciation
Depreciation
=( Cost of the asset - Salvage value) /life time
= (1520000 - 20000)/5
= 1500000 / 5
= $300000
Free Cash flow 1-4 years
1st year Free Cash flow
EBIT
600000
Less: Tax 40%(600000*40%)
240000
360000
Add: Depreciation
300000
Free Cash Flow
$660,000
2nd year Free Cash flow
EBIT
700000
Less: Tax 40%(700000*40%)
280000
420000
Add: Depreciation
300000
Free Cash Flow
$720,000
3rd year Free Cash flow
EBIT
550000
Less: Tax 40%(550000*40%)
220000
330000
Add: Depreciation
300000
Free Cash Flow
$630,000
4th year Free Cash flow
EBIT
200000
Less: Tax 40%(200000*40%)
80000
120000
Add: Depreciation
300000
Free Cash Flow
$420,000
Irr where Npv = zero
NPV = cash inflows – Cash out flows
Note:-
As you should not ask more then one question in single post we should not provide answer but I provide first two questions and some hints for remaining Thankyou.
Initial outlay
Cost of the asset
1500000
Additional working capital
20000
Total Initial Outlay
$1,520,000
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