Consider a project that involves the purchase of a $10,000 machine that will red

Question

Consider a project that involves the purchase of a $10,000 machine that will reduce pretax operating costs by $3,000 per year over the next five years.  It will not require any changes in net working capital and is expected to have a salvage value of $1,000 in five years.  The machine will be depreciated according to the five-year MACRS schedule (note that this schedule has 6 years of depreciation, but the machine will be sold after 5 years).  The tax rate is 34%, and the discount rate is 10%.  Construct a table of the relevant cash flows, and compute the NPV and IRR.  Round all amounts to the nearest dollar.

1             20

2             32

3             19.20

4            11.52       

5            11.52

6             5.76

Show all work.  Thank you

Explanation / Answer

Hi,

Please find the answer as follows:

Part 1: Relevant Annual Cash Inflows:

Notes:

Book Value at the End of 5 Year = 10000-5200-1920-1152-1152 = 576

Profit on Book Value = 1000 (Salvage Value) - 576 = 424

Tax on Profit = 424*(.34) = 144

Net Capital Spending/Benefit (at the end of 5 Year) = 1000 - 144 = 856

Part B:

NPV = -10000 + 2660/(1+.10)^1 + 3068/(1+.10)^2 + 2633/(1+.10)^3 + 2372/(1+.10)^4 + 3228/(1+.10)^5 = 556.37 or 556

IRR,

To calculate the value of IRR, you need to put the value of NPV as 0 and solve for r in the following equation:

NPV = 0 = -10000 + 2660/(1+r)^1 + 3068/(1+r)^2 + 2633/(1+r)^3 + 2372/(1+r)^4 + 3228/(1+.r)^5

Solving for r , we get IRR as: 12.14%

IRR = 12.136 or 12.14%

Thanks.

Relevant Annual Cash Flow Statement
0 1 2 3 4 5 Sales
0 0 0 0 0 Cost
-3000 -3000 -3000 -3000 -3000 Net Benefit
3000 3000 3000 3000 3000 Less Depreciation
2000 3200 1920 1152 1152 Net Benefit after Depreciation
1000 -200 1080 1848 1848 Less Taxes
340 -68 367 628 628 Add Depreciation
2000 3200 1920 1152 1152 Operating Cash Flow
2660 3068 2633 2372 2372 Add Net Capital Spending/Benefit -10000 0 0 0 0 856 Relevant Annual Cash Flow -10000 2660 3068 2633 2372 3228

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

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