New project analysis Holmes Manufacturing is considering a new machine that cost

Question

New project analysis

Holmes Manufacturing is considering a new machine that costs $230,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $26,000 at the end of its 5-year operating life. The applicable depreciation rates are 33%, 45%, 15%, and 7%. Net operating working capital would increase by $24,000 initially, but it would be recovered at the end of the project's 5-year life. Holmes' marginal tax rate is 40%, and a 12% WACC is appropriate for the project.

Calculate the project's NPV. Round your answer to the nearest cent.
$   

Calculate the project's IRR. Round your answer to two decimal places.
%

Calculate the project's MIRR. Round your answer to two decimal places.
%

Calculate the project's payback. Round your answer to two decimal places.
years

Assume management is unsure about the $90,000 cost savings-this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of these situations? Round your answers to the nearest cent.
20% savings increase. $   
20% savings decrease. $   

Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine's salvage value, and the net operating working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis:

Calculate the project's expected NPV, its standard deviation, and its coefficient of variation. Round your answers to two decimal places.

E(NPV) = $   

NPV = $   

CV =  

Scenario Probability Cost Savings Salvage Value NOWC Worst case 0.35 $72,000 $21,000 $29,000 Base case 0.35 $90,000 $26,000 $24,000 Best case 0.30 $108,000 $31,000 $19,000

Explanation / Answer

Year Details Add: savings in tax Add back :tax shield due to depn.on depble. Value 204000 Net cash flow PV F @ 12% PV @ 12% 0 Initial cost -230000 -230000 1 -230000 0 NWC introduced -24000 -24000 1 -24000 1 Annual savings 90000 36000 26928 152928 0.89286 136543 2 90000 36000 36720 162720 0.79719 129719 3 90000 36000 12240 138240 0.71178 98396 4 90000 36000 13872 139872 0.63552 88891 5 90000 36000 126000 0.56743 71496 5 NWC recovered 24000 24000 0.56743 13618 5 SalvageLess Tax 15600 15600 0.56743 8852 NPV of the Project 293516 IRR Net cash flows Year 0 -254000 1 152928 2 162720 3 138240 4 139872 5 165600 Project IRR (as per Excel) 52.82% Project Pay back period= Total initial investment 254000 1 st year C/F 152928 balance in 2nd year= 254000-152928= 101072 ie. 12/162720*101072= 7.5 months So, payback period is 1 year 7.5 months MIRR Inflow Future value of Year 5 165600 1 165600 4 139872 (1.12)^1 156656.6 3 138240 1.12^2 175455.4 2 162720 1.12^3 196510.1 1 152928 1.12^4 220091.3 Future value of 914313.5 cash inflows MIRR = nth root of (Future value of cash inflows/Pv of cash outflows) -1 where n is the no.of yrs. ie. 5th root of( 914314/254000 ) -1= 1.29197-1= 0.29197= 29.20% 20% Increase Year Details Add: savings in tax Add back :tax shield due to depn.on depble. Value 204000 Net cash flow PV F @ 12% PV @ 12% 0 Initial cost -230000 -230000 1 -230000 0 NWC introduced -24000 -24000 1 -24000 1 Annual savings 108000 43200 26928 178128 0.89286 159043 2 108000 43200 36720 187920 0.79719 149808 3 108000 43200 12240 163440 0.71178 116333 4 108000 43200 13872 165072 0.63552 104907 5 108000 43200 151200 0.56743 85795 5 NWC recovered 24000 24000 0.56743 13618 5 SalvageLess Tax 15600 15600 0.56743 8852 NPV of the Project 384357 20% Decrease in annual savings Year Details Add: savings in tax Add back :tax shield due to depn.on depble. Value 204000 Net cash flow PV F @ 12% PV @ 12% 0 Initial cost -230000 -230000 1 -230000 0 NWC introduced -24000 -24000 1 -24000 1 Annual savings 72000 28800 26928 127728 0.89286 114043 2 72000 28800 36720 137520 0.79719 109630 3 72000 28800 12240 113040 0.71178 80460 4 72000 28800 13872 114672 0.63552 72876 5 72000 28800 100800 0.56743 57197 5 NWC recovered 24000 24000 0.56743 13618 5 SalvageLess Tax 15600 15600 0.56743 8852 NPV of the Project 202676 BEST CASE SCENARIO Year Details Add: savings in tax Add back :tax shield due to depn.on depble. Value 204000 Net cash flow PV F @ 12% PV @ 12% 0 Initial cost -230000 -230000 1 -230000 0 NWC introduced -19000 -19000 1 -19000 1 Annual savings 108000 43200 26928 178128 0.89286 159043 2 108000 43200 36720 187920 0.79719 149808 3 108000 43200 12240 163440 0.71178 116333 4 108000 43200 13872 165072 0.63552 104907 5 108000 43200 151200 0.56743 85795 5 NWC recovered 19000 19000 0.56743 10781 5 SalvageLess Tax 18600 18600 0.56743 10554 NPV of the Project 388222 WORST CASE SCENARIO Year Details Add: savings in tax Add back :tax shield due to depn.on depble. Value 204000 Net cash flow PV F @ 12% PV @ 12% 0 Initial cost -230000 -230000 1 -230000 0 NWC introduced -29000 -29000 1 -29000 1 Annual savings 72000 28800 26928 127728 0.89286 114043 2 72000 28800 36720 137520 0.79719 109630 3 72000 28800 12240 113040 0.71178 80460 4 72000 28800 13872 114672 0.63552 72876 5 72000 28800 100800 0.56743 57197 5 NWC recovered 29000 29000 0.56743 16455 5 SalvageLess Tax 12600 12600 0.56743 7150 NPV of the Project 198811 Scenario Probability NPV P* NPV Worst case 0.35 198811 69583.85 Base case 0.35 293516 102730.6 Best case 0.3 388222 116466.6 Expected NPV= Sum= 288781.05 ie. 288781 Scenario NPV Dev= NPV-288781 Dev^2 P*Dev^2 Worst case 198811 -89970 8094600900 2833110315 Base case 293516 4735 22420225 7847078.75 Best case 388222 99441 9888512481 2966553744 Variance 5807511138 Standard deviation - Sq.rt of variance= 76207.0281 ie. $ 76207 Coefficient of variation CV= 76207/288781= 0.2639

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