Question

The table below offers EBIT for a potential capital investment for Fake Company Zeta. (This same project will be used for all of your FMC #3 work.) You should be able to determine a few things once you consider the following:

• The initial investment is $4,000.
• Depreciation is straight line over four years.
• The company's WACC is estimated at 15.0%.
• Company analysts estimate that a proper salvage value at the end of the project life of four years is about 30% of the initial investment.
• The company's tax rate is 30.0%.

	YEAR 1	YEAR 2	YEAR 3	YEAR 4
EBIT	$500	$650	$700	$1,100

What is this project's internal rate of return?

Enter your number as a regular percent - without percent signs or commas. Round to the nearest first decimal. There is a small error range of +/– 0.05.

For example, if you calculated 12.064%, you will enter 12.1. Or if you calculated as a decimal number of 0.12064, you will enter 12.1.

Answer 1

The initial investment of the project is $4000.

The depreciation charged per year is : $4,000/ 4 = $1000

The Cash flows for year 1 to year 4 is:

YEAR 1 : EBIT* (1 - TAX RATE) + DEPRECIATION

= $500 * 0.7 + 1000

= $1,350

YEAR 2 : 650* 0.7 + $1000

=$1455

YEAR 3 : 700 * 0.7 + 1000

= 490 + 1000

= $1490

YEAR 4 : EBIT( 1 - TAX RATE ) + DEPRECIATION + AFTER TAX SALVAGE VALUE

= $1100* 0.7 + 1000 + 30% * 4000 * 0.7

=$770 + 1000 + 840

=$2610

CFO = ($4000)

CF1 = $1350

CF2 = $1455

CF3 = $1490

CF4 = $2610

IRR = 23