Use NPV and IRR analysis to decide whether ToysRus should purchase a new molding
ID: 2793738 • Letter: U
Question
Use NPV and IRR analysis to decide whether ToysRus should purchase a new molding machine that costs $127,000. Information about the project:
– Installation will cost $20,000.
– $4,000 in net working capital will be needed at the time of installation.
– The project will increase revenues by $85,000 per year, but operating costs will increase by 35% of the revenue increase.
– Simplified straight line depreciation is used.
– Class life is 5 years, and the firm is planning to keep the project for 5 years.
– Salvage value at year 5 will be $50,000.
– Firms with similar risk as ToysRushave required return of 14%.
– 34% marginal tax rate.
Find Initial Outlay, Annual Cash flows, Terminal Cash flows using their formulas
Explanation / Answer
Initial Outlay = 127,000 + 4,000 + 20,000 = 151,000
Annual Cash Flows = Profits + Depreciation = 17061 + 147,000 / 5 = 46,461
Terminal Cash Flows = Annual Cash Flows + NWC + After-tax Salvage = 46,461 + 4,000 + 50,000 x (1 - 34%) = 83,461
In excel, IRR = IRR(-151000....83461) = 20.78%
NPV = NPV(14%, 46461...83461) - 151000 = $27,721.02
As the NPV > 0, IRR > 14%, ToysRu should purchase the machine.
ToysRU 0 1 2 3 4 5 Investment -147000 NWC -4000 4000 Salvage 50000 Revenues 85000 85000 85000 85000 85000 Costs -29750 -29750 -29750 -29750 -29750 Depreciation -29400 -29400 -29400 -29400 -29400 EBT 25850 25850 25850 25850 25850 Tax (34%) -8789 -8789 -8789 -8789 -8789 Profits 17061 17061 17061 17061 17061 Cash Flows -151000 46461 46461 46461 46461 83461 IRR 20.78% NPV $27,721.02Related Questions
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