Question

Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses of $300,000. An inventory investment of $75,000 is required during the life of the project. Read Book Company is in the 25 percent tax bracket, and its existing cost of capital is 8 percent. a. Calculate the initial outlay of the project b. Calculate the annual after-tax operating cash flow for Years 1 -4. c. Determine the terminal year non-operating cash flow in year 4: d. What is the equipment NPV? e. What is the estimated Internal Rate of Return (IRR) of the equipment? f. Should the equipment be accepted based on the IRR criterion?

Answer 1

Read Book	0	1	2	3	4
MACRS %		0.3333	0.4445	0.1481	0.0741
Investment	-1,130,000
Salvage					350,000
NWC	-75,000				75,000
Revenues		600,000	600,000	600,000	600,000
Expenses		-300,000	-300,000	-300,000	-300,000
Depreciation		-376,629	-502,285	-167,353	-83,733
EBT		-76,629	-202,285	132,647	216,267
Tax (25%)		19,157	50,571	-33,162	-54,067
Profits		-57,472	-151,714	99,485	162,200
OCF		319,157	350,571	266,838	245,933
Cash Flows	-1,205,000	319,157	350,571	266,838	583,433
NPV	$31,740
IRR	9.08%

Depreciation = MACRS % x Investment

OCF = Profits + Depreciation

Cash Flows = Investment + NWC + Salvage x (1 - tax) + Profits + Depreciation

NPV and IRR can be calculated using the same function in excel.

Equipment should be accepted as its IRR > 9%