\"A manufacturing company has just received an order with the following financia
ID: 2789871 • Letter: #
Question
"A manufacturing company has just received an order with the following financial data. All dollar values are given in constant dollars, and inflation will impact the annual revenue, annual operating cost, and the salvage value. The two-year project requires immediately purchasing equipment for $46,000. The equipment falls into the MACRS 5-year class. The machine will be sold for $17,000 at the end of two years. The project will bring in additional annual revenue of $119,000, but it is expected to incur an additional annual operating cost of $27,000. The firm expects a general inflation rate of 5% per year during the project period. The firm's tax rate is 45%, and its market interest rate is 21%. What is the net present worth of this project?"
Explanation / Answer
The inital outlay of the project is FCinv + WCinv
Here the cost of equipment is 46000 and no increase in working capital , thus
Initial outlay = FCinv + WCinv
=46000 + 0
=46000
Depreciation of the equipment is based on 5 year class and thus the depreciation for first 2 years according to MACRS 5 year is 20% and 32%
Thus depreciation in year = 9200
and for year two = 46000*0.32 = 14720
Now book value of machine at the end of year 2 = 46000-9200-14720=22080
And the salvage value for the machine given is 17000 with tax rate given as 45%
Terminal year cashflow = Salvage + Wcinv - tax*(salvage-book value)
=17000+0 - 0.45*(17000-22080)
=17000 - (-2286)
=19286
(and this amount will get added to final year operating cashflow)
After tax operating cashflow = (Sales-Cost-Depreciation)*(1-tax)+Depreciation
For year = 54740
For year two = (119000-27000-14720)*(1-0.45)+14720 = 57224
(we will add terminal year CF to year two and it will be 57224+19286=76510)
Please see the below schedule for NPV calculation. NPV can also be calculated by inserting respective cashflows in your financial calculator and by pressing CPT then entering 21% as discount rate and pressing NPV:
Year
Cash Flows
0
-46000
1
54740
2
76510
NPV at 21%
$42,559.53
Thus net present worth of the project is $42599.53
Year
Cash Flows
0
-46000
1
54740
2
76510
NPV at 21%
$42,559.53
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