Question

1. Kylie Cosmetics is evaluating the proposed acquisition of a new production machine. The machine's base price is $270,000, and installation costs would amount to $38,000. An additional $15,000 in net working capital would be required at installation. The machine has a class life of 4 years based on straight line depreciation. The machine would save the firm $120,000 per year in operating costs. The firm is planning to keep the machine in place for 5 years. At the end of the fifth year, the firm plans to sell the machine for $120,000. The firm has a required rate of return on investment projects of 12% and a marginal tax rate of 34%. What is the IRR of the project?

Answer 1

Year-o $0 $0 $0 $0 $0 $308,000 Year-1 $120,000 $77,000 $43,000 $14,620 $28,380 Year-2 Year-3 $120,000 $120,000 $77,000 $77,000 $43,000 $43,000 $14,620 $14,620 $28,380 $28,380 Year-4 $120,000 $77,000 $43,000 $14,620 $28,380 Savings in annual operating costs Less: Depreciation exepense Income before income taxes Income tax expense (34%) Net income Machine cost including installation After-tax salvage value at the end Working capital investment Working capital recovery at the end Add back depreciation expense Net Cash Flow Year-5 $120,000 $0 [$308000 / 4 years] $120,000 (Given] -$40,800 [Income before income taxes x 34%] $79,200 [$270,000 + $38,000] $79,200 [$120000 x (1-34%) --> Entire sale value chargeable to tax as book value will be zero] $15,000 $77,000 $105,380 $77,000 $77,000 $105,380 $105,380 $77,000 $105,380 $15,000 (Usually recovered at the end of project] $0 [Non-cash expense and so added back] $173,400 $323,000 Internal Rate of Return (IRR) 22.53% [Ref: EXCEL SCREENSHOT] EXCEL SCREENSHOT: 1 Year-o So $o $o =-B4434% =B4+B5 =-270000-38000 Year-1 $120,000 =B7/4 =SUM(C2:03) =-C4°34% =C4+C5 D Year-2 $120,000 -B7/4 =SUM(D2:03) =-D4*34% =D4+D5 E Year-3 $120,000 =B7/4 =SUM(E2:E3) =-E4*34% =E4+E5 Year-4 $120,000 =B7/4 =SUM(F2:F3) =-F4*34% =F4+F5 G Year-5 $120,000 SO =SUM(G2:G3) =-G4*34% =G4+G5 Savings in annual operating costs Less: Depreciation exepense Income before income taxes 5 Income tax expense (34%) 6 Net income 7 Machine cost including installation 8 After-tax salvage value at the end 9 Working capital investment 10 Working capital recovery at the end 11 Add back depreciation expense 12 Net Cash Flow 13 =120000*(1-34%) -$15,000 =-C3 =SUM(C6:C11) =SUM(B6:B11) =-D3 =SUM(D6:011) =-E3 =SUM(E6:E11) =-B9 =-G3 =SUM(G6:611) --F3 =SUM(F6:F11)