Introduction You will assume that you still work as a financial analyst for AirJ
ID: 2702551 • Letter: I
Question
Introduction
You will assume that you still work as a financial analyst for AirJet Best Parts, Inc. The company is considering a capital investment in a new machine and you are in charge of making a recommendation on the purchase based on (1) a given rate of return (Task 4) and (2) the firm%u2019s cost of capital (Task 5).
NOTE: You are to submit your work using the Project 2 template provided in the %u201CCourse Project Requirements Files%u201D area under the %u201CDoc Sharing%u201D tab in the course shell. Assignments will not be accepted if this template is not used.
Task 4. Capital Budgeting for a New Machine
A few months have now passed and AirJet Best Parts, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows:
Year 1 $1,200,000
Year 2 $1,350,000
Year 3 $1,400,000
Year 4 $850,000
You have now been tasked with providing a recommendation for the project based on the results of a Net Present Value Analysis. Assuming that the required rate of return is 16.25% and the initial cost of the machine is $3,500,000:
1. What is the project%u2019s IRR? (10 pts)
2. What is the project%u2019s NPV? (15 pts)
3. Should the company accept this project and why (or why not)? (5 pts)
4. Explain how depreciation will affect the present value of the project. (10 pts)
5. Explain why NPV and IRR are better methods to use for this decision than the Payback method: (15 pts)
6. Assuming that you were going to do a sensitivity analysis of this project, what would be some project-specific risks and market risks that should be incorporated into that analysis? (20 pts)
You will assume that you still work as a financial analyst for AirJet Best Parts, Inc. The company is considering a capital investment in a new machine and you are in charge of making a recommendation on the purchase based on (1) a given rate of return (Task 4) and (2) the firm%u2019s cost of capital (Task 5). NOTE: You are to submit your work using the Project 2 template provided in the %u201CCourse Project Requirements Files%u201D area under the %u201CDoc Sharing%u201D tab in the course shell. Assignments will not be accepted if this template is not used. Task 4. Capital Budgeting for a New Machine A few months have now passed and AirJet Best Parts, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows: You have now been tasked with providing a recommendation for the project based on the results of a Net Present Value Analysis. Assuming that the required rate of return is 16.25% and the initial cost of the machine is $3,500,000: What is the project%u2019s IRR? What is the project%u2019s NPV? Should the company accept this project and why (or why not)? Explain how depreciation will affect the present value of the project. Explain why NPV and IRR are better methods to use for this decision than the Payback method: Assuming that you were going to do a sensitivity analysis of this project, what would be some project-specific risks and market risks that should be incorporated into that analysis?Explanation / Answer
Annual depreciation using SLN = 3500000/4 = 875000
1. What is the project%u2019s IRR? (10 pts)
IRR = IRR(CF0....CF4)
ie IRR = IRR(-3500000,1200000,1350000,1400000,850000)
ie IRR = 14.57%
2. What is the project%u2019s NPV? (15 pts)
NPV = NPV(16.25%,1200000,1350000,1400000,850000)-3500000
ie NPV = -$112,213.74
3. Should the company accept this project and why (or why not)? (5 pts)
No. As NPV is negative, Projectis not viable
4. Explain how depreciation will affect the present value of the project. (10 pts)
Depreciation will not affect the NPV in absence of Tax breaks.
Here OCF = ANticipated CF - Dep + Dep written back = ANticpayted CF
SO there is no Dep effect.
5. Explain why NPV and IRR are better methods to use for this decision than the Payback method: (15 pts)
NPV & IRR uses Time value of money concepts while PBP is plain average of Returns over the project life. It doesn't consider cost of capital.
6. Assuming that you were going to do a sensitivity analysis of this project, what would be some project-specific risks and market risks that should be incorporated into that analysis? (20 pts)
Project Risk :
a. Increase in competition of the product supplier will reduce cash flow as prices will drop
b. Delay in project implementation
Market risk :
a. Cost of capital may increase due to credit issues/economic conditions
b. The special part demand may fluctuate depending upon economic factors
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