Q#1 Would you accept the project based on NPV, IRR? Explain. Q#2 Tax Reform Act

Question

Q#1 Would you accept the project based on NPV, IRR? Explain.                                                                                                            

Q#2 Tax Reform Act of 2017 allows Equipment expenses to be depreciated in year #1                             

       A) Estimate NPV, IRR and Payback Period of the project.                                                                   

       B) Estimate NPV, IRR and Payback Period of the project if Equipment is fully depreciated in first year and corporate marginal tax is dropped to 20%

       C) As a shareholder of the firm, would you prefer (a) or (b)? Why?                                                                            

Q# 3 How would you explain to your CEO (in business terms) what NPV means?                                 

Q#4 What are the advantages and disadvantages of using NPV versus IRR?          

1) Life Period of the Equipment = 4 years 8) Sales for first year (1) $   200,000 2) New equipment cost $ (200,000) 9) Sales increase per year 5% 3) Equipment ship & install cost $    (35,000) 10) Operating cost: $ (120,000) 4) Related start up cost $      (5,000)     (as a percent of sales in Year 1) -60% 5) Inventory increase $      25,000 11) Depreciation (Straight Line)/YR $    (60,000) 6) Accounts Payable increase $        5,000 12) Tax rate 35% 7) Equip. salvage value after tax $      15,000 13) WACC 10% ESTIMATING CASH FLOW and MAKING CAPITAL BUDGETING DECISION Year 0 1 2 3 4 Investments: 1) Equipment cost 2) Shipping and Install cost 3) Start up expenses     Total Basis Cost (1+2+3) 4) Net Working Capital      Total Initial Outlay xxxxx Operations: Revenue Operating Cost Depreciation    EBIT Taxes    Net Income Add back Depreciation      Total Operating Cash Flow XXXXX XXXXX XXXXX XXXXX Terminal: 1) Change in net WC $    -   $    -   $    -   $ 20,000 2) Salvage value (after tax) $ 15,000    Total $ 35,000      Project Net Cash Flows $          -   $    -   $    -   $    -   $ NPV = IRR = Payback= Use Excel Spreadsheet to compute cash flows, NPV, RR and Pay Back Period $ 200,000 5% $(120,000) -60% 11) Depreciation (Straight LinehYR $ (60,000) 35% 10% 1) Life Period of the Equipment 4years 2) New equipment cost 3) Equipment ship&install; cos $ (35,000) 4) Related startup cost 8) Sales forfrstyear () 9) Sales increase peryear 10) Operating cost $ (5,000) $ 25,000 5,000 15,000 (as a percent of sales in Year1) 6) Accounts Payable increase $ 7) Equip. salvage value after tD $ 12) Tax rate 13) WACC ESTLAATNG CASH FLOW and MAKNG CAPITAL BUDGETING DECISION 0 2 3 ear Investments: 1) Equipment cost 2) Shipping and Instal cost 3) Start up expenses Total Basis Cost (1+2+3) 4) Net Working Capital Total Initial Outay XXXx Operations: Revenue Operating Cost Depreciation EBIT Taxes Net Income Add back Depreciation Total Operating Cash Flow Tenminal 1) Change in net WC 2) Salvage value (after tax) $ 20,000 15,000 $ 35,000 Total Project Net Cash Flows $ IRR = Payback-

Explanation / Answer

Calculation of NPV and IRR of the project -

1. NPV of the project would be = 7057.23

IRR of the project would be = 11.16%

yes i would accept the project based on NPV and IRR due to NPV is positive and IRR is greater than WACC.

2. (A) If all 100% depriciation expense allowed in year 1 then the calculation would be as follwos -

as per above calculation NPV of the project is -34055.4

and IRR = 3.96

so i would not be accept the project.

Calculation of Payback period

payback period = 3+68070/95196.5

= 3 year & 8.58 months

B Calculation of NPV, IRR and Payback period in case of 2(B) option -

Calcualtion of Payback period -

Payback period = 3+42240/109088*12

= 3 years and 4,64months

C) No as NPV is coming negative and IRR is lower than WACC.

Q3 NPV stands for Net present value which is present value of cash inflow - present value of cash outflow

if PVCI > PVCO accepts the project otherwise reject.

Q4 IRR Merit - does not use the concept of required rate of return or cost of capital. It itself provides a rate of return which is indicative of the profitability of the project.

IRR Demerit - It has tedious calculation

Merit of NPV - It explicitly recognises the time value of money.

Demerit of NPV - Calculation fo required rate of return to discount the cash flows.

Please note all values are in $.

In case of any calrification required please comment.

Year 0 1 2 3 4 NPV & IRR Investments: Equipment cost 200000 shipping and intallation cost 35000 startup expenses 5000 Total Basis cost 240000 Operation: Revenue 200000 210000 220500 231525 Operating cost @60% of sales 120000 126000 132300 138915 Depriciation 60000 60000 60000 60000 EBIT 20000 24000 28200 32610 Less Taxes @ 35% 7000 8400 9870 11413.5 EBT 13000 15600 18330 21196.5 add Depriciation 60000 60000 60000 60000 Total operating cash flow 73000 75600 78330 81196.5 Terminal : Changes in WC 20000 20000 Salvage value 15000 Projected net cash flows -260000 73000 75600 78330 116196.5 11.16% Discounting @ 10% 1 0.909091 0.826446 0.751315 0.683013 PV -260000 66363.64 62479.34 58850.49 79363.77 7057.237

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