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Project Analysis and Inflation Mustaine Enterprises, Inc., has been considering

ID: 2709722 • Letter: P

Question

Project Analysis and Inflation Mustaine Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $272,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $107,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 5 percent. Production costs at the end of the first year will be $32,000, in nominal terms, and they are expected to increase at 6 percent per year. The real discount rate is 8 percent. The corporate tax rate is 34 percent. Mustaine has other ongoing profitable operations. Should the company accept the project?

Year 0

Year 1

Year 2

Year3

Year4

Year5

Year6

Year7

Revenues

$107,000

$112,350

$117,967.5

$123,865.9

$130,059.2

$136,562.1

$143,390.2

Costs

32,000

33,920

35,955.2

38,112.51

40,399.26

42,823.22

45,392.61

Depreciation

EBT

Taxes @34%

Net Income

OFC

Capital Spending

($272,000)

Cash Flow

($272,000)

Solve for NPV

Year 0

Year 1

Year 2

Year3

Year4

Year5

Year6

Year7

Revenues

$107,000

$112,350

$117,967.5

$123,865.9

$130,059.2

$136,562.1

$143,390.2

Costs

32,000

33,920

35,955.2

38,112.51

40,399.26

42,823.22

45,392.61

Depreciation

EBT

Taxes @34%

Net Income

OFC

Capital Spending

($272,000)

Cash Flow

($272,000)

Explanation / Answer

Solution :

Year 0

Year 1

Year 2

Year3

Year4

Year5

Year6

Year7

Revenues

107,000.00

107,000.00

107,000.00

107,000.00

107,000.00

107,000.00

107,000.00

Costs

    32,000.00

    32,000.00

    32,000.00

    32,000.00

    32,000.00

    32,000.00

    32,000.00

Depreciation

    38,857.14

    38,857.14

    38,857.14

    38,857.14

    38,857.14

    38,857.14

    38,857.14

EBT

    36,142.86

    36,142.86

    36,142.86

    36,142.86

    36,142.86

    36,142.86

    36,142.86

Taxes @34%

    12,288.57

    12,288.57

    12,288.57

    12,288.57

    12,288.57

    12,288.57

    12,288.57

Net Income

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    62,711.43

    62,711.43

    62,711.43

    62,711.43

    62,711.43

    62,711.43

    62,711.43

Discounting factor at 8%

       0.92593

       0.85734

       0.79383

       0.73503

       0.68058

       0.63017

       0.58349

PV of Cash inflow

    58,066.14

    53,764.94

    49,782.35

    46,094.77

    42,680.34

    39,518.84

    36,591.52

Total of pv of cash inflow

   326,498.90

PV of Cash outflow

   272,000.00

NPV

     54,498.90

Hence company should accept the project as NPV is positive

Year 0

Year 1

Year 2

Year3

Year4

Year5

Year6

Year7

Revenues

107,000.00

107,000.00

107,000.00

107,000.00

107,000.00

107,000.00

107,000.00

Costs

    32,000.00

    32,000.00

    32,000.00

    32,000.00

    32,000.00

    32,000.00

    32,000.00

Depreciation

    38,857.14

    38,857.14

    38,857.14

    38,857.14

    38,857.14

    38,857.14

    38,857.14

EBT

    36,142.86

    36,142.86

    36,142.86

    36,142.86

    36,142.86

    36,142.86

    36,142.86

Taxes @34%

    12,288.57

    12,288.57

    12,288.57

    12,288.57

    12,288.57

    12,288.57

    12,288.57

Net Income

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    23,854.29

    62,711.43

    62,711.43

    62,711.43

    62,711.43

    62,711.43

    62,711.43

    62,711.43

Discounting factor at 8%

       0.92593

       0.85734

       0.79383

       0.73503

       0.68058

       0.63017

       0.58349

PV of Cash inflow

    58,066.14

    53,764.94

    49,782.35

    46,094.77

    42,680.34

    39,518.84

    36,591.52

Total of pv of cash inflow

   326,498.90

PV of Cash outflow

   272,000.00

NPV

     54,498.90