Question

Graziano Corporation (GC) is considering a project to purchase new equipment. The equipment would be depreciated by the straight-line method over its 3-year life and would have a zero-salvage value. The project requires an investment of $6,000 today on net working capital. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other company’s products and would reduce its pre-tax annual cash flows of $5,000 per year. The investment on the project costs $76,000 today plus $4,000 installation cost. The project generates sales revenues of $67,500 each year for 3 years. The annual operating costs of the project is $25,000, excluding depreciation. GC has a weighted average cost of capital 11.00% and its tax rate is 35 percent. The company can sell the equipment at the end of the third year to generate $10,000 after-tax cash flow. What is the project's MIRR and NPV Graziano Corporation (GC) is considering a project to purchase new equipment. The equipment would be depreciated by the straight-line method over its 3-year life and would have a zero-salvage value. The project requires an investment of $6,000 today on net working capital. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other company’s products and would reduce its pre-tax annual cash flows of $5,000 per year. The investment on the project costs $76,000 today plus $4,000 installation cost. The project generates sales revenues of $67,500 each year for 3 years. The annual operating costs of the project is $25,000, excluding depreciation. GC has a weighted average cost of capital 11.00% and its tax rate is 35 percent. The company can sell the equipment at the end of the third year to generate $10,000 after-tax cash flow. What is the project's MIRR and NPV

Answer 1

1]	Cost of investment+installation = 76000+4000 =	$              80,000.00
	Increase in NWC	$                6,000.00
	Initial outlay	$              86,000.00
2]	Annual revenue from the project	$              67,500.00
	-Annual operating costs other than depreciation	$              25,000.00
	-Depreciation = 80000/3 =	$              26,666.67
	-Reduction in other products' pretax cash flow	$                5,000.00
	-Incremental NOI	$              10,833.33
	-Tax at 35%	$                3,791.67
	=Incremental NOPAT	$                7,041.67
	+Depreciation	$              26,666.67
	=Incremenal OCF	$              33,708.33
3]	After tax cash outflow from sale of equipment	$              10,000.00
	Recovery of NWC	$                6,000.00
	Terminal non operating cash flows	$              16,000.00
4]	PV of incremental OCF = 33708.33*(1.11^3-1)/(0.11*1.11^3) =	$              82,373.54
	PV of terminal non operating cash flows = 16000/1.11^3 =	$              11,699.06
	Sum of PV of cash inflows	$              94,072.60
	Less: Initial investment	$              86,000.00
	NPV	$                8,072.60
5]	MIRR assumes that intervening cash flows are invested at WACC. Hence, the
	FV of the cash inflows, namely the annual incremental OCF and the terminal
	non-operating cash flows are calculated. It is done below:
	FV of incremental OCF = 33708.33*(1.11^3-1)/(0.11) =	$          1,12,656.61
	FV of terminal non operating cash flows	$              16,000.00
	Sum of FV of cash inflows	$          1,28,656.61
	Now we have only two cash flows for the project.
	1] The sum of FVs of the inflows which, is equal to $128,656.61 at t3, and
	2] The initial cash outflow of $86,000 at t0.
	Now MIRR is the discount rate that equals the two.
	That is 86000 = 128656.61/(1+MIRR)^3
	Hence,
	MIRR = (128656.61/86000)^(1/3)-1 =	14.37%