Homework Answers
| Problem 2 | ||||||||
| (a) | ||||||||
| Cashflow Estimate | ||||||||
| Year | Initial Investment | Tax Adjusted Net Revenue | Salvage Value | Working Capital | Tax Savings on Depreciation | Net Cashflow | ||
| 0 | (15,000,000) | - | - | (3,000,000) | - | (18,000,000) | ||
| 1 | - | 6,750,000 | - | - | 1,083,333 | 7,833,333 | ||
| 2 | - | 6,750,000 | - | - | 1,083,333 | 7,833,333 | ||
| 3 | - | 6,750,000 | 2,000,000 | 3,000,000 | 1,083,333 | 12,833,333 | ||
| 10,499,999 | ||||||||
| Calculation of Annual Tax Adjusted Net Revenue | ||||||||
| Sales | 20,000,000 | |||||||
| Less: Annual Costs | 11,000,000 | |||||||
| Net Revenue | 9,000,000 | |||||||
| Less: Tax @ 25% | 2,250,000 | |||||||
| Tax Adjusted Net Revenue | 6,750,000 | |||||||
| Note | ||||||||
| Depreciation = Investment - Salvage Value = | 15,000,000 -2,000,000 | = 4,333,333 | ||||||
| Number of years | 3 | |||||||
| Tax Savings on Depreciation = 4,333,333 x 25% = 1,083,333 | ||||||||
| (b) | ||||||||
| Net Present Value = $ 2,796,088 | ||||||||
| Year | Net Cashflow | PVF @ 16% | Present Value | |||||
| 0 | (18,000,000) | 1 | (18,000,000) | |||||
| 1 | 7,833,333 | 0.8621 | 6,752,873 | |||||
| 2 | 7,833,333 | 0.7432 | 5,821,442 | |||||
| 3 | 12,833,333 | 0.6407 | 8,221,773 | |||||
| 2,796,088 | ||||||||
| (c) IRR = 24.52% | ||||||||
| IRR is the rate at which NPV or Net Present Value equals zero. | ||||||||
| Lets do it by trial and error method. | ||||||||
| Here, we have positive NPV which means we need to raise the discounting percentage | ||||||||
| Let us try it with 20% | Let us try it with 25% | |||||||
| Year | Net Cashflow | PVF @ 30% | Present Value | Year | Net Cashflow | PVF @ 40% | Present Value | |
| 0 | (18,000,000) | 1 | (18,000,000) | 0 | (18,000,000) | 1 | (18,000,000) | |
| 1 | 7,833,333 | 0.8333 | 6,527,778 | 1 | 7,833,333 | 0.8000 | 6,266,666 | |
| 2 | 7,833,333 | 0.6944 | 5,439,815 | 2 |
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