Assume an investment project that has 250,000 dollars of capital cost for purcha

Question

Assume an investment project that has 250,000 dollars of capital cost for purchasing some machines and 150,000 dollars for buying a piece of land at time zero. The project life time is 8 years. This investment yields the annual revenue for 95,000 dollars and operating cost of 25,000 dollars for 8 years (from year 1 to year 8). At the end of the project life (8th year), the land will be sold at 180,000. Consider the straight line method to deprecate the investment for machines equally over 8 years (year 1 to year 8) and apply income tax of 40%. Calculate ATCF and ROR for this project. Please explain your work.

Explanation / Answer

Part A)

The statement showing calculation of after-tax cash flows is given below:

__________

Part B)

The rate of return can be calculated with the use of IRR function of EXCEL. The basic formula for calculating IRR is given below:

NPV = 0 = Cash Flow Year 0 + Cash Flow Year 1/(1+IRR)^1 + Cash Flow Year 2/(1+IRR)^2 + Cash Flow Year 3/(1+IRR)^3 + Cash Flow Year 4/(1+IRR)^4 + Cash Flow Year 5/(1+IRR)^5 + Cash Flow Year 6/(1+IRR)^6 + Cash Flow Year 7/(1+IRR)^7 + Cash Flow Year 8/(1+IRR)^8

__________

The ROR has been calculated with the use of EXCEL as follows:

ROR = 8.89%

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Initial Investment (-250,000 -150,000) -400,000 Annual Revenue 95,000 95,000 95,000 95,000 95,000 95,000 95,000 95,000 Less Annual Operating Cost 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 Less Depreciation (250,000/8) 31,250 31,250 31,250 31,250 31,250 31,250 31,250 31,250 EBT 38,750 38,750 38,750 38,750 38,750 38,750 38,750 38,750 Taxes (EBT*40%) 15,500 15,500 15,500 15,500 15,500 15,500 15,500 15,500 EAT 23,250 23,250 23,250 23,250 23,250 23,250 23,250 23,250 Add Depreciation 31,250 31,250 31,250 31,250 31,250 31,250 31,250 31,250 Salvage Value of Land 0 0 0 0 0 0 0 180,000 Less Tax on Sale of Land (180,000 – 150,000)*40% 0 0 0 0 0 0 0 12,000 After Tax Cash Flow -$400,000 $54,500 $54,500 $54,500 $54,500 $54,500 $54,500 $54,500 $246,500

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