To find: The
Introduction:
The variation between the present value of the cash outflows and the present value of the cash inflows are known as the net present value. In capital budgeting the net present value is utilized to analyze the profitability of a project or investment. The rate of return which equates the initial investment and the present value of net cash inflows are referred to as internal rate of return. This is also called as actual rate of return.
Answer to Problem 32QP
The net present value is $4,725,575.74 and the internal
Explanation of Solution
Given information:
Company A projects the unit sale for the new 7 octave voice emulation implant as follows:
- The year 1 unit sales is 84,000
- The year 2 unit sales is 98,000
- The year 3 unit sales is 113,000
- The year 4 unit sales is 106,000
- The year 5 unit sales is 79,000
The production implant needs $1,500,000 in the net working capital to begin their production activities. The extra net working capital investment for every year is equivalent to the 15% of the sales that is projected has to rise for the following year. The total fixed cost is $3,400,000 for a year, the unit price is $395, and the variable production cost is $265. The installation cost of the equipment is $17,000,000.
The equipment is qualified in the 7 Year MACRS depreciation under the property class. In 5 years the equipment sale can be sold for 20% of its acquisition cost. The marginal tax bracket is 35 percent and has the required rate of return which is 18%.
MACRS depreciation table for year 7:
MACRS Depreciation table for seven year | |
Year | Seven year |
1 | 14.29% |
2 | 24.49% |
3 | 17.49% |
4 | 12.49% |
5 | 8.93% |
6 | 8.92% |
7 | 8.93% |
8 | 4.46% |
Computation of the net present value:
Computation of the
Table showing the cash inflows:
Year | 1 | 2 | 3 | 4 | 5 |
Ending book value | $14,570,700 | $10,407,400 | $7,434,100 | $5,310,800 | $3,792,700 |
Sales | $33,180,000 | $38,710,000 | $44,635,000 | $41,870,000 | $31,205,000 |
Less: Variable costs | -$22,260,000 | -$25,970,000 | -$29,945,000 | -$28,090,000 | -$20,935,000 |
Fixed costs | -$3,400,000 | -$3,400,000 | -$3,400,000 | -$3,400,000 | -$3,400,000 |
Depreciation | -$2,429,300 | -$4,163,300 | -$2,973,300 | -$2,123,300 | -$1,518,100 |
EBIT | $5,090,700 | $5,176,700 | $8,316,700 | $8,256,700 | $5,351,900 |
Less: Taxes | -$1,781,745 | -$1,811,845 | -$2,910,845 | -$2,889,845 | -$1,873,165 |
Net income | $3,308,955 | $3,364,855 | $5,405,855 | $5,366,855 | $3,478,735 |
Add: Depreciation | $2,429,300 | $4,163,300 | $2,973,300 | $2,123,300 | $1,518,100 |
Operating cash flow | $5,738,255 | $7,528,155 | $8,379,155 | $7,490,155 | $4,996,835 |
Net cash inflows: | |||||
Operating cash flow | $5,738,255 | $7,528,155 | $8,379,155 | $7,490,155 | $4,996,835 |
Change in net working capital | –829,500 | –888,750 | $414,750 | $1,599,750 | $1,203,750 |
Capital spending | $0 | $0 | $0 | $0 | $3,537,445 |
Total cash inflows | $4,908,755 | $6,639,405 | $8,793,905 | $9,089,905 | $9,738,030 |
Computations for the above table:
Formula to calculate the ending book value:
Computation of the ending book value for year 1:
Formula to calculate the sales:
Computation of the sales:
Computation of the depreciation:
The depreciation amount is calculated by using the MACRS depreciation table for seven years.
Formula to calculate depreciation:
Computation of the depreciation:
Formula to calculate the taxes:
Computation of the taxes:
Formula to calculate the net working capital:
Computation of the net working capital:
Computation of the net working capital for the year 5:
Computation of the ending book value:
Formula to calculate the after-tax salvage value:
Computation of the after-tax salvage value:
Formula to calculate the net present value:
Computation of the net present value:
Hence, the net present value is $4,725,575.74.
Computation of the internal rate of return:
The internal rate of return is calculated by the spreadsheet method.
Step 1:
- Type the formulae of the internal rate of return in H6 in the spreadsheet and consider the IRR value as H8
Step 2:
- Assume the IRR value as 0.10%
Step 3:
- In the spreadsheet go to data and select the what-if analysis.
- In what-if analysis select goal seek
- In set cell select H6 (the formulae)
- The To value is considered as 0
- The H8 cell is selected for the by changing cell.
Step 4:
- Following the previous step click OK in the goal seek. The goal seek status appears
Step 5:
- The IRR value appears to be 27.5164749401034%
Hence, the internal rate of return is 27.52%.
Want to see more full solutions like this?
Chapter 10 Solutions
Fundamentals of Corporate Finance
- New-Project Analysis The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $605,000. The MACRS rates for the first 3 years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of $15,500. The sprayer would not change revenues, but it is expected to save the firm $380,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 35%. What is the Year-0 cash flow? What are the net operating cash flows in Years 1, 2, and 3? What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of working capital)? If the project’s cost of capital is 12%, should the machine be purchased?arrow_forwardRedbird Company is considering a project with an initial investment of $265,000 in new equipment that will yield annual net cash flows of $45,800 each year over its seven-year life. The companys minimum required rate of return is 8%. What is the internal rate of return? Should Redbird accept the project based on IRR?arrow_forwardAustins cell phone manufacturer wants to upgrade their product mix to encompass an exciting new feature on their cell phone. This would require a new high-tech machine. You are excited about his new project and are recommending the purchase to your board of directors. Here is the information you have compiled in order to complete this recommendation: According to the information, the project will last 10 years and require an initial investment of $800,000, depreciated with straight-line over the life of the project until the final value is zero. The firms tax rate is 30% and the required rate of return is 12%. You believe that the variable cost and sales volume may be as much as 10% higher or lower than the initial estimate. Your boss understands the risks but asks you to explain the alternatives in a brief memo to the board, Write a memo to the Board of Directors objectively weighing out the pros and cons of this project and make your recommendation(s).arrow_forward
- Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost 9,000,000 and last 10 years. The companys cost of capital is 12 percent. Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchasedeven if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of 1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of 300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the companys decision?arrow_forwardThe projects review committee of Microsoft has $20 million to allocate next year to new software product development. Any or all of five projects in the table below may be accepted. All amounts are in $1000 units. Each project has an expected life of 7 years. Select the project(s) if a 13% return is expected.arrow_forwardAguilera Acoustics, Inc. (AAI), projects unit sales for a newseven-octave voice emulation implant as follows: Year Unit Sales 1 8300 2 9200 3 10400 4 9800 5 8400 Production of the implants will require GH¢ 150,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales for that year. In the final year of the project, net working capital will decline to zero as the project is wound down. In other words, the investment in working capital is to be completely recovered by the end of the project’s life. Total fixed costs are GH¢ 240,000 per year, variable production costs are GH¢ 190 per unit, and the units are priced at GH¢ 345 each. The equipment needed to begin production has an installed cost of GH¢ 2,300,000. Because the implants are intended for professional singers, this equipment depreciated using the straight-line basis. In five years,…arrow_forward
- T8. Accountarrow_forwardRevenues generated by a new fad product are forecast as follows: Year Revenues 1 $ 50,000 2 35,000 3 30,000 4 20,000 Thereafter 0 Expenses are expected to be 40% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an immediate investment of $60,000 in plant and equipment. Required: What is the initial investment in the product? Remember working capital. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight - line depreciation, and the firm's tax rate is 20%, what are the project cash flows in each year? If the opportunity cost of capital is 10%, what is project NPV?arrow_forwardCooper Industriesarrow_forward
- JS er st un gs Sunland, Inc. management is considering purchasing a new machine at a cost of $4,370,000. They expect this equipment to produce cash flows of $791,390, $796,950, $866,730, $1,116,300, $1,212,360, and $1,300,900 over the next six years. If the appropriate discount rate is 15 percent, what is the NPV of this investment? (Enter negative amounts using negative sign e.g. -45.25. Do not round discount factors. Round other intermediate calculations and final answer to 0 decimal places, e.g. 1,525.) The NPV is tA $arrow_forward0. A $45,000 investment in a new conveyor system is projected to improve throughput and increasing revenue by $14,000 per year for five years. The conveyor will have an estimated market value of $4,000 at the end of five years. Using NPV with a MARR of 12%, is this a good investment?arrow_forwardNPV. Miglietti Restaurants is looking at a project with the following forecasted sales: first-year sales quantity of 33,000, with an annual growth rate of 4.00% over the next ten years. The sales price per unit will start at $41.00 and will grow at 2.00% per year. The production costs are expected to be 55% of the current year's sales price. The manufacturing equipment to aid this project will have a total cost (including installation) of $2,100,000. It will be depreciated using MACRS, and has a seven-year MACRS life classification. Fixed costs will be $360,000 per year. Miglietti Restaurants has a tax rate of 40%. What is the operating cash flow for this project over these ten years? Find the NPV of the project for Miglietti Restaurants if the manufacturing equipment can be sold for $140,000 at the end of the ten-year project and the cost of capital for this project is 8%. MACRS Fixed Annual Expense Percentages by Recovery Class Year 3-Year…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTManagerial AccountingAccountingISBN:9781337912020Author:Carl Warren, Ph.d. Cma William B. TaylerPublisher:South-Western College PubSurvey of Accounting (Accounting I)AccountingISBN:9781305961883Author:Carl WarrenPublisher:Cengage Learning
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage LearningIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage LearningFinancial And Managerial AccountingAccountingISBN:9781337902663Author:WARREN, Carl S.Publisher:Cengage Learning,