EMGT 6225 report

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Northeastern University *

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6225

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Economics

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Feb 20, 2024

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1 EMGT 6225: Economic Decision Making Guided by: Prof. Mohammad Dehghani Sumanth Tallapanani August 20 , 2023

2 Table of Contents 1.0 Problem Definition 3 1.1 Problem Choices 3 1.1.1 Capital Sources 3 1.1.2 Machine 3 1.1.3 Tax Rate 3 1.1.4 Inflation Rate 3 2.0 Proposed Solution 4 2.1 Calculation of WACC 4 2.2 Calculate MARR 4 2.3 Calculation of BTCF 5 2.4 Calculation of BTCF EWA 5 2.5 Calculation of Tax Rate 6 2.6 Calculation of After-Tax Cash Flow 6 2.7 Calculation of After-Tax Cash Flow Post Inflation 7 3.0 Conclusion 7

3 1.0 Problem Definition A $8M investment is considered by an electric bike manufacturing company to add a new production line for its new product, electric skateboards. The company has commissioned an exploratory study of where to place the new production line and which type of equipment to use. There are three types of machines to choose from for the company to install on the new assembly line. The machines have zero salvage value at the end of 10-year planning horizon. The company must select at least two alternatives from (i) Loan, (ii) Common Stocks, (iii) Preferred Stocks, and (iv) Retained Earnings to obtain the required amount of capital for the investment. Each of these capital sources could provide $4M to support the project. The company is anticipating rapid product penetration and aggressive growth after addition of the new production line. The major question for this case study is to find out if the project is economically justified. 1.1 Problem Choices Capital Sources: 3, 1 Machine: 1 Tax Rate: 2 Inflation Rate: 2 1.1.1 Capital Sources Preferred Stock Divedend= $7 Price= $100 Brokerage Fee= $3 1.1.2 Machine No. of Machines: 20 First Cost: $200,000 Operating Cost/Hr.: $120 Revenue/Hr.: $170 Hr./Year: 1500 Life: 10 years Depreciation (MACRS): 5years 1.1.3 Tax Rate State Tax Rate: 7% Federal Tax Rate: 21% 1.1.4 Inflation Rate Inflation Rate: 5%

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4 2.0 Proposed Solution 2.1 Calculation of WACC The inputs taken into account for the initial WACC calculation for Loan and Retained Earnings are as shown in Image 2.1.a Image 2.1.a Based on the calculation we get a WACC= 5.612%. (Rounded off to 6%) 2.2 Calculate MARR The following step is to calculate MARR using the options given to me, specifically WACC (rounded off) + 4%. After taking into account my alternatives, the MARR is as follows: 6% + 4%= 10%. The same is shown in image 2.2.a Image 2.2.a

5 2.3 Calculation of BTCF For BTCF (Before Tax cash flow), Given option 1 for Machine, the calculation is as per image 2.3.a Image 2.3.a 2.4 Calculation of BTCF EWA With the help of Excel function, we have calculated few parameters as follows:  PW in excel can be calculated as ‘=NPV’  DPBP is ‘=NPER’  Similarly, IRR is ‘=IRR’

6 Image 2.4. 2.5 Calculation of Tax Rate With the help of the below formula the tax rate is calculated Tax rate = State tax + Federal Tax * (1-State Tax) Image 2.5.a 2.6 Calculation of After-Tax Cash Flow Few more parameters are calculated using the below formulae. AT MARR: Before Tax MARR*(1-Income Tax rate) PPMT (Excel formula) ‘=PPMT’ IPMT (Excel Function) ‘=IPMT’ DWO by following MACRS 5 years table Taxable income: subtracting BTCF, IPMT and DWO columns. Tax: Taxable income * ITR Image 2.6.a

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7 2.7 Calculation of After-Tax Cash Flow Post Inflation With the given inflation rate the after-tax cash flow is calculated here as show in the image 2.7.a My analysis shows: The investments we are considering are financially viable because the economic rate of return (ERRr) is greater than the minimal economic rate of return (MARR), or ERRr>MARR. Even after accounting for inflation, the investment's NPV (net present value) is positive. indicating that the venture represents a lucrative investment opportunity.

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