Chapter 7 Problem 12 a). Complete the spreadsheet below by estimating the projec

Question

Chapter 7 Problem 12






















a). Complete the spreadsheet below by estimating the project's annual after tax cash flow.










b).  What is the investment's net present value at a discount rate of 10 percent?










c).  What is the investment's internal rate of return?










d).  How does the internal rate of return change if the discount rate equals 20 percent?










e). How does the internal rate of return change if the growth rate in EBIT is 8 percent instead of 3 percent?






















Facts and Assumptions










Equipment initial cost $ $350,000









Depreciable life yrs. 7









Expected life yrs. 10









Salvage value $ $0









Straight line depreciation










EBIT in year 1 28,000









Tax rate 38%









Growth rate in EBIT 3%









Discount rate 10%





















Year 0 1 2 3 4 5 6 7 8 9 10 Initial cost 350,000









Annual depreciation
50,000 50,000 50,000 50,000 50,000 50,000 50,000


EBIT
28,000 28,840 29,705 30,596 31,514 32,460 33,433 34,436 35,470 36,534 Chapter 7 Problem 12






















a). Complete the spreadsheet below by estimating the project's annual after tax cash flow.










b).  What is the investment's net present value at a discount rate of 10 percent?










c).  What is the investment's internal rate of return?










d).  How does the internal rate of return change if the discount rate equals 20 percent?










e). How does the internal rate of return change if the growth rate in EBIT is 8 percent instead of 3 percent?






















Facts and Assumptions










Equipment initial cost $ $350,000









Depreciable life yrs. 7









Expected life yrs. 10









Salvage value $ $0









Straight line depreciation










EBIT in year 1 28,000









Tax rate 38%









Growth rate in EBIT 3%









Discount rate 10%





















Year 0 1 2 3 4 5 6 7 8 9 10 Initial cost 350,000









Annual depreciation
50,000 50,000 50,000 50,000 50,000 50,000 50,000


EBIT
28,000 28,840 29,705 30,596 31,514 32,460 33,433 34,436 35,470 36,534

Explanation / Answer

1. After tax cash flow = EBIT*(1-tax) + Depreciation

2. investment's net present value = -3,50,000 + 67360/1.1+ 67880.80/1.1^2 + 68417.22/1.1^3.....22650.86/1.1^10 = $12,922.73

3. For internal rate of return, NPV =0

-3,50,000 + 67360/(1+IRR)+ 67880.80/(1+IRR)^2 + 68417.22/(1+IRR)^3.....22650.86/(1+IRR)^10 = 0

IRR = 10.99%

4. if the discount rate equals 20 percent, IRR remains unchanged.

5. if the growth rate in EBIT is 8 percent instead of 3 percent, the table will change to

For IRR, NPV =0

-3,50,000 + 67360/(1+IRR)+ 68748.80/(1+IRR)^2 + 70248.70/(1+IRR)^3.....34702.72/(1+IRR)^10 = 0

IRR = 12.80%

Year 0 1 2 3 4 5 6 7 8 9 10 Initial Cost 3,50,000 Annual depreciation 50,000 50,000 50,000 50,000 50,000 50,000 50,000 EBIT 28,000.00 28,840.00 29,705.20 30,596.36 31,514.25 32,459.67 33,433.46 34,436.47 35,469.56 36,533.65 After Tax Cash Flow 67360.00 67880.80 68417.22 68969.74 69538.83 70125.00 70728.75 21350.61 21991.13 22650.86

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