The South Seas Navigation Company is considering buying new sextants for its cel

Question

The South Seas Navigation Company is considering buying new sextants for its celestial navigation school. The sextants cost $34,000 and are expected to generate annual net cash flows before taxes of $7,500 per year for 9 years. The sextants will be depreciated using straight-line depreciation for 10 years; however they will be sold in 9 years for $6,000. The corporate tax rate is 34%. The required rate of return for this project is 12%. If South Seas decides to buy the new sextants, it will sell its old sextants, which have a book value of $4,000 and originally cost $10,000, for $8,000.
a. Calculate the initial investment, annual operating cash flows, and terminal value.
b. Calculate the project's NPV
c. Calculate the project's IRR.
d. Calculate the project's MIRR.

Explanation / Answer

a. Calculate the initial investment, annual operating cash flows, and terminal value.

Initial investment = New sextants cost - Post Tax Sale Value of Old sextants

Initial investment = 34000 - (8000 - 34%*(8000-4000))

Initial investment = $ 27360

Annual operating cash flows =  annual net cash flows before taxes *(1-tax rate) + Depreciation * tax rate

Annual operating cash flows = 7500*(1-34%) + 34000/10*34%

Annual operating cash flows = $ 6106

Terminal value = Post Tax Salvage Value

Terminal value = 6000 - 34%*(6000 - 34000*(1-9/10))

Terminal value = $ 5116

b. Calculate the project's NPV

NPV = -initial investment + Annual operating cash flows*PVA(rate,nper) +  Terminal value*PV(rate,nper)

NPV = -27360 + 6106*PVA(12%,9) + 5116*PV(12%,9)

NPV = -27360 + 6106*5.32825 + 5116*0.36061

NPV = $ 7019.18

c. Calculate the project's IRR.

IRR = rate(nper,pmt,pv,fv)

IRR = rate(9,6106,-27360,5116)

IRR = 18.07%

d. Calculate the project's MIRR

FV of cash inflow = 6106*((1+12%)^9 - 1)/12% + 5116

FV of cash inflow = $ 95,336.16

PV of Cash Outflow = 27360

MIRR = (FV of cash inflow/PV of Cash Outflow )^(1/9) - 1

MIRR = (95336.16/27360)^(1/9) -1

MIRR = 14.88%

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