Question

You must analyze a potential new product—a caulking compound that Cory Materials' R&D people developed for use in the residential construction industry. Cory's marketing manager thinks the company can sell 115,000 tubes per year for 3 years at a price of $3.25 each, after which the product will be obsolete. The required equipment would cost $150,000, plus another $15,000 for shipping and installation. Current assets (receivables and inventories) would increase by $35,000, while current liabilities (accounts payable and accruals) would rise by $15,000. Variable costs would be 60% of sales revenues, fixed costs (exclusive of depreciation) would be $70,000 per year, and fixed assets would be depreciated using the straight line method. When production ceases after 3 years, the equipment is expected to have no market value. Cory's tax rate is 40%, and it uses a 10% WACC for average-risk projects. Find the required Year O investment and the project's annual net cash flows. Then calculate the project's NPV, IRR, MIRR, and payback. Assume at this point that the project is of average risk.

The answer should include the relevant formula or equation and the final numbers

Answer 1

Answer:

NPV:

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.

Further, Changes in these working capital accounts work to either increase or decrease cash flow. Cash flow increases as accounts receivables decrease or as accounts payables increase. Accordingly, cash flow decreases as accounts receivables increase or accounts payables decrease. Therefore, as working capital changes from period to period, it has an effect on cash flow which, in turn, has an effect on NPV.

	Present Value of Cash Inflows
	Particulars		$
	Sales		3,73,750
	Variable Cost @ 60%		2,24,250
	Fixed Cost		70,000
	Net Profit		79,500
	Less Depn per year		55,000
	=(150000+15000)/3
	Net profit for tax computation		24,500
	Tax @ 40%		9,800
	Net Profit after Tax		14,700
	Add: Depn		55,000
	Revenue for the year		69,700
	*Discounting Factor for 3 years
	(0.9091+0.8264+0.7513)		2.4868
A	Present Value of revenue		1,73,330
	Cash Outflow
	Cost of Equipment		1,50,000
	Cost of Installation		15,000
B	Cost of Initial Investment		1,65,000
	Working Capital
	Increase in Current Assets means decrease in Cash Flow		35,000
	Increase in Current Liabilities means increase in Cash Flow		-15,000
C	Overall decrease in Working Capital at Present		20,000
	Net Present Value	(A-B+C)	28,330

IRR:

Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero. Therefore, the present value of cash inflow

Present Value of Cash Outflow:

Initial Cost	165000
Less: Reduction in Working Capital	-20000
Cash Outflow	145000

Revenue per year derived above = 69700 $

When discounted @ 20% the Present of Revenue for 3 years = $ 146821.75

When discounted @ 22% the Present of Revenue for 3 years = $ 142344.23

Therefore, IRR = [(145000-142344.23)*2 ] / (146821.75 - 142344.23) = 0.8137

IRR = 20 + 0.8137 = 20.8137 %

Modified IRR:

Calculate the Terminal value of Inflows::

Cash Inflow	Duration	Rate	Working	Terminal Value
69,700	2 years	10%	(69,700 x 1.10^2)	84,337
69,700	1 years	10%	(69,700 x 1.10^1)	76,670
69,700	0 years	10%	(69,700 x 1)	69,700
				2,30,707

Step 2: Calculate the Present value of Outflows:

Cash Inflow	Duration	Rate	Working	Terminal Value
145,000	0 year	-		145,000

Step 3: Calculate MIRR

MIRR = Terminal Value of Cash Inflows - Present Value of Cash Outflows - 1

In Excel we can directly compute MIRR using MIRR Function: = 21%

10%) Outflow Inflow Yr 1 Inflow Yr 2 Inflow Yr 3D -145000 84337 76670 69700 =MIRR(H9:H12,19,J9)