Evaluate the following capital budgeting project. ABC is evaluating an investment in specialized equipment for a cost of $700 million (including installation and modification expenses). The equipment is defined as a three-year asset to be depreciated to a zero-salvage value. The firm can depreciate 33% of the investment in Year 1 and 45% in Year 2 when the equipment will be sold, net of expenses, to another organization for $200 million. The investment is projected to generate $300 million per year pre-tax, net operating income for the two years the equipment is retained. The firm pays income taxes and capital gains taxes at the 20% marginal rate. The firm is profitable and would offset taxes (or recapture prior taxes paid) in any year the project is unprofitable. The firm’s weighted, average after-tax cost of capital is 4.00% and the cost of equity is 5.00%. a) Develop the annual after-tax, pre-leverage operating, and non-operating cash flow for the investment for year zero, year one and year two. Label all cash flows. b) Derive the NPV or the IRR for the project and indicate whether and why the project is acceptable or unacceptable.
Evaluate the following capital budgeting project. ABC is evaluating an investment in specialized equipment for a cost of $700 million (including installation and modification expenses). The equipment is defined as a three-year asset to be depreciated to a zero-salvage value. The firm can
a) Develop the annual after-tax, pre-leverage operating, and non-operating cash flow for the investment for year zero, year one and year two. Label all cash flows.
b) Derive the NPV or the IRR for the project and indicate whether and why the project is acceptable or unacceptable.
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