Question

1. Assume that you are analyzing a proposed asset acquisition where the assets will cost $5 million, plus $200,000 to have them delivered and installed. The project will result in sales of 6000 units in the first year of operations. The sales price will be $190 per unit and the operating costs (excluding depreciation) will be $140 per unit. The assets will be depreciated using the MACRS 5-year rates. The project will require a level of net working capital of 5% of the following year’s sales. The number of units sold is expected to increase by 20% per year in the second year of the project. Growth is estimated to be 15% in the third year, and 0 in the fourth year. The sales price and operating costs per unit are expected to remain the same for the length of the project. The assets will have a salvage value of $450,000 at the end of four years. Calculate the Initial Investment Outlay for the project, and the Net Operating Cash Flows for the four years of this project and the terminal cash flow. Assume a tax rate of 40%. If the appropriate cost of capital is 8%, calculate the Profitability Index, Internal Rate of Return, and Payback Period for this project. Should it be accepted? Why or why not?

Answer 1

Solulion Given that 2, A ovest ment Captlalied Cost - 5,200 000 3.00.19.20/..52 MACRS Depre cialion |664 0o0998,400|599040 oyoi 000 Tax Saving depre ciation 665600399.360239,616B 416 000 898.560 Book value 1-5a + 516% Salvage valuclsv (sy-Bv)x tox - a CF 450,000 Salvage value (sv) Required c0orking 999' 8E - -48 '660 5,000 -68,100 Capital chang e cworking captal in net -lo 260 -5t,000 8660 0 D. operation unit Sales Sales price 190 190 190 ogerating Costs 40 40 ahi Pe1 cunft i140 000 /36000l573,2001/513,0o Revenue

Totacost 000ah8 Revenue-to tal З00 000 |360»000 |ч14000 |ч142000 Cost Tay , о091991-| 0оgr991-| 000hhl-| 0001де. Cash Flow 180-000 |а16б00 |24 8 чро 248400. |E FCF -5/25100 584600S1l/3y0 |641,4601,196iloo. A1B+C+D- Npv@s7 |-2,515,286 Reject this inVestmeot IRR -15-09/ high as t doeS even TecOVer Payback periody| inittal investroert is so Years