Calculate the project’s NPV, IRR, MIRR and Payback period. Should the project be

Question

Calculate the project’s NPV, IRR, MIRR and Payback period. Should the project be accepted?

After several months, they felt Central should go ahead with the project. They would set up production in an unused section of their main plant. New machinery with an estimated cost of $2,100,000 would be purchased. Shipping would cost $150,000 and there would be an additional charge of the same amount for installation. Inventories would increase by $75,000 and receivables would increase by $125,000. The machinery was estimated to have a useful life of four years. Depreciation would be on the Modified Accelerated Cost Recovery System (MACRS) with allowances of 33%, 45%, 15% and 7% for the four years of its useful life. The machinery is expected to be sold after four years for $150,000.

The company had been thinking about leasing the unused portion of the factory that is scheduled to be used for the new project. They had received several interesting offers, the most favorable of which was for $20,000 per year.

Annual sales of the new product were estimated to be 150,000 cases at $35 per case. Costs, excluding depreciation, would be 80% of sales. It was felt that existing sales would be cannibalized by $20,000 per year.

Management believes financing would not be a problem. They currently have a capital structure of 50% debt and 50% common equity which they wish to maintain (preferred stock has never been issued). Debt would cost 12% and common stock, given a risk free rate of 5%, a market return of 12% and a beta of 1.7, would be affordable. The company has a marginal tax rate of 40%.

Cost of Equity = 17%

Working Average Cost of Capital: 12%

Explanation / Answer

Cost of the New Machinery and depreciation :- PARTICULARS Amount in $ 1) New machinery estimated cost 2100000 2) Shipping expenses 150000 3) Installation charges 150000 4) Total cost of the asset 24,00,000 5) Salvage value at the end of 4 years 150000 6) Usefull Life of the asset 4 years 7) Depreciation under MACRS :      Year 1    Dep. = $ 24,00,000 x 33% 792000      Year 2    Dep. = $ 24,00,000 x 45% 1080000      Year 3    Dep. = $ 24,00,000 x 15% 360000      Year 4    Dep. = $ 24,00,000 x 7% 168000 2400000 Calculation of Cash Inflows :- Year 1 Year 1 Year 2 Year 3 Year 4 Year 4 Salvage Particulars Amount in $ Amount in $ Amount in $ Amount in $ Amount in $ 1) Annual sales {150000 cases * $35 per case} 5250000 5250000 5250000 5250000 2) Less: costs excluding depreciation @80% (5250000*80%) -4200000 -4200000 -4200000 -4200000 3) Cash inflows before depreciation 1050000 1050000 1050000 1050000 4) Less: depreciation under MACRS -792000 -1080000 -360000 -168000 5) Cash flow after depreciation before tax 258000 -30000 690000 882000 6) Less: tax @40% 103200 0 276000 352800 7)cash flow after tax 154800 -30000 414000 529200 8) Add: Depreciation (non-cash item) 792000 1080000 360000 168000 9) Lease rent per annum 20000 20000 20000 20000 10) Less: Working capital (wc is same for the 4 years period so not deducted) 0 0 0 0 11) Total cash inflows per annum(7 : 9) 966800 1070000 794000 717200 150000 12) present value annuity factor at 12% 0.8928 0.7972 0.7117 0.6355 0.6355 13) Present value of inflows / initial outflow -2400000 863159 853004 565090 455781 95325 14) NET PRESENT VALUE $ 432,358 Calculation of Weighted Average cost of capital :- Particulars Proporation cost of capital DEBT 0.50 0.072 {0.12(100-40)%} EQUITY 0.50 0.17 Given weighted average capital   = (0.50 * 0.072) + (0.50 * 0.17) = 0.121 or 12.10% Calculation of Pay back period :- cash out flow/ cash inflow= $ 2,400,000 / $ 432,358 = 5.55 years Calculation of Required rate of return using CAPM :- Return = Rf + Beta (Market return - Risk free return) = 5% + 1.7 (12% - 5%) Required rate of return = 16.9% or 17% (rounded off) STATEMENT SHOWING CALCULATION OF IRR Year 1 Year 1 Year 2 Year 3 Year 4 Year 4 Salvage Particulars Amount in $ Amount in $ Amount in $ Amount in $ Amount in $ 1) Annual sales {150000 cases * $35 per case} 5250000 5250000 5250000 5250000 2) Less: costs excluding depreciation @80% (5250000*80%) -4200000 -4200000 -4200000 -4200000 3) Cash inflows before depreciation 1050000 1050000 1050000 1050000 4) Less: depreciation under MACRS -792000 -1080000 -360000 -168000 5) Cash flow after depreciation before tax 258000 -30000 690000 882000 6) Less: tax @40% 103200 0 276000 352800 7)cash flow after tax 154800 -30000 414000 529200 8) Add: Depreciation (non-cash item) 792000 1080000 360000 168000 9) Lease rent per annum 20000 20000 20000 20000 10) Less: Working capital (wc is same for the 4 years period so not deducted) 0 0 0 0 11) Total cash inflows per annum(7 : 9) 966800 1070000 794000 717200 150000 12) present value annuity factor at 17% 0.8547 0.7305 0.6243 0.5336 0.5336 13) Present value of inflows / initial outflow -2400000 826324 781635 495694 382698 80040 14) NET PRESENT VALUE $ 166,391 Calculation of IRR :- NPV at 12%{at lower rate} 432358 NPV at 17% 166391 IRR = 12% + 432358-166391/166391 * 1 = 14%

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