ISBN-13: 978-1-111-97221-9 Madison Manufacturing is considering a new machine th

Question

ISBN-13: 978-1-111-97221-9

Madison Manufacturing is considering a new machine that cost $350,000 and would reduce pre-tax manufacturing costs by $110,000 annually. Madison would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $33,000 at the end of its 5-year operating life. The applicable depreciation rates are 33.33%, 44.45%, 14.81% and 7.42%, as discussed in Appendix 11A. Working capital would increase by $35,000 initially, but it would be recovered at the end of the project's 5-year life. Madison's marginal tax rate is 40%, and a 10% WACC is appropriate for the project.

a. Calculate the project's NPV, IRR MIRR and payback.

b. Assume management is unsure about the $110,000 cost savings - this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of theses extremes?

I like to start by setting up a timeline. I'm a visual learner

I like to start by setting up a timeline

0 1 2 3 4 5 -350000 35000 110000 110000 110000 110000

Explanation / Answer

a. NPV

IRR - For this find the rate at which NPV is negative and then interpolate the rate using the above NPV which is postive. At IRR the NPV is zero. Here 11% is taken

That means for zero NPV the rate lies between 10 and 11.

Interpolation will give the IRR at 10.74%

Verification

Payback

When the total amount invested in the project is recovered it is called payback. The time within which it is recovered is payback period. It is different from discounted payback.

Total amount recovered till year 3 in the first table of rate 10% (non discounted)- 292626

Total amount recovered till year 4 in the first table of rate 10% (non discounted)- 369014

time required to recover the amount of Rs. 3,50,000/- = (369014-350000)/(369014-292626) = 3.25 years

b).

Year Net of tax annual savings Tax savings on Depreciation Capital gain on sale of maching Working Capital Total inflow pvf @ 10% Inflow * pvf 0 - 1 66000 46662 0 -35000 77662 0.909 70601.82 2 66000 62230 0 128230 0.826 105975.2 3 66000 20734 0 86734 0.751 65164.54 4 66000 10388 0 76388 0.683 52174.03 5 66000 0 19800 35000 101000 0.621 62713.05 356628.6 Outflow = (350000) Net Present value 6628.648

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.