I need help on how to go about answering the following question for a quiz. Thor
ID: 2761475 • Letter: I
Question
I need help on how to go about answering the following question for a quiz.
Thornley Machines is considering a 3-year project with an initial cost of $618,000. The project will not directly produce any sales but will reduce operating costs by $265,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated $60,000. The tax rate is 34%. The project will require $23,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a 9% rate of return? Why or why not?
Explanation / Answer
CF0=-$618,000+(-$23,000)=-$641,000
Annual depreciation= $618,000 /3=$206,000
Taxes= ($265,000-$206,000) x 0.34 =$20,060
OCF=$265,000-$20,060=$244,940
CF3=$244,940+[$60,000 x (1-0.34 ] +$23,000=$307,540
Year
CashFlow
PV Factor@ 9%
PV
0
(641,000)
1
(641,000.00)
1
244,940
0.9174
224,715.60
2
244,940
0.8417
206,161.10
3
307,540
0.7722
237,477.31
NPV
27,354.00
Yes , Project can be implemented as NPV is postive
Year
CashFlow
PV Factor@ 9%
PV
0
(641,000)
1
(641,000.00)
1
244,940
0.9174
224,715.60
2
244,940
0.8417
206,161.10
3
307,540
0.7722
237,477.31
NPV
27,354.00
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