Madison Manufacturing is considering a new machine that costs $350,000 and wouldreduce pre-tax manufacturing costs by $110,000 annually. Madison would use the 3-yearMACRS method to depreciate the machine, and management thinks the machine wouldhave a value of $33,000 at the end of its 5-year operating life. The applicabledepreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. Working capital wouldincrease by $35,000 initially, but it would be recovered at the end of the project's 5-yearlife. Madison's marginal tax rate is 25%, and a 10% cost of capital is appropriate for theproject.1. Calculate the project's NPV, IRR, MIRR, and payback.2. Assume management is unsure about the $110,000 cost savings this figurecould deviate by as much as plus or minus 20%. What would the NPV be undereach of these extremes?3. Suppose the CFO wants you to do a scenario analysis with different values for thecost savings, the machine's salvage value, and the working capital (WC)requirement. She asks you to use the following probabilities and values in thescenario analysis:ScenarioWorst caseBase CaseBest caseProbability0.350.350.30Cost Savings$ 88,000110,000132,000Salvage Value$28,00033,00038,000WC$40,00035,00030,000Calculate the project's expected NPV, its standard deviation, and its coefficient ofvariation. Would you recommend that the project be accepted?

Capital Budgeting refers to the process of allocating the planned capital expenditure to various…

Answered: NPV, IRR, MIRR

Business

Economics

NPV, IRR, MIRR

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Madison Manufacturing is considering a new machine that costs $350,000 and would
reduce pre-tax manufacturing costs by $110,000 annually. Madison would use the 3-year
MACRS method to depreciate the machine, and management thinks the machine would
have a value of $33,000 at the end of its 5-year operating life. The applicable
depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. Working capital would
increase by $35,000 initially, but it would be recovered at the end of the project's 5-year
life. Madison's marginal tax rate is 25%, and a 10% cost of capital is appropriate for the
project.
1. Calculate the project's NPV, IRR, MIRR, and payback.
2. Assume management is unsure about the $110,000 cost savings this figure
could deviate by as much as plus or minus 20%. What would the NPV be under
each of these extremes?
3. Suppose the CFO wants you to do a scenario analysis with different values for the
cost savings, the machine's salvage value, and the working capital (WC)
requirement. She asks you to use the following probabilities and values in the
scenario analysis:
Scenario
Worst case
Base Case
Best case
Probability
0.35
0.35
0.30
Cost Savings
$ 88,000
110,000
132,000
Salvage Value
$28,000
33,000
38,000
WC
$40,000
35,000
30,000
Calculate the project's expected NPV, its standard deviation, and its coefficient of
variation. Would you recommend that the project be accepted?

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Step 1: Capital Budgeting:

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Step 2: Determining the NPV, IRR, MIRR and the payback period:

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Step 3: Calculating the NPV, IRR, MIRR, and the payback period:

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Step 4: 2. Computing the NPV when under different cost savings:

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Step 5: 3.Computing the NPV under the best and worst case scenarios:

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Step 6: Computing the project's expected NPV, Standard deviation and coefficient of variation:

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