Question

n Holmes Manufacturing is considering a new machine that costs $260,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS method to depreciate the machine, and managemer hinks the machine would have a value of $24,000 at the end of its 5-year operating life. The applicable depreciation ates are 33%, 45%, 15 % , and 7 % . Net operating working capital would increase by $26,000 initially, but it would be recovered at the end of the project's 5-year life. Holmes's marginal tax rate is 40%, and a 10 % WACC is appropriate for the project. a. Calculate the project's NPV. Round your answer to the nearest cent. Calculate the project's IRR. Round your answer to two decimal places. % Calculate the project's MIRR. Round your answer to two decimal places. Calculate the project's payback. Round your answer to two decimal places. years b. Assume management is unsure about the $90,000 cost savings-this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of these situations? Round your answers to the nearest cent. Negative amount should be indicated by a minus sign. 20% savings increase. $ 20% savings decrease. $ c. Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine's salvage value, and the net operating working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis: Scenario Probability Cost Savings Salvage Value NOWC Worst case 0.35 $72,000 $19,000 $31,000 Base case 0.35 90,000 24,000 26,000 Best case 0.30 108,000 29,000 21,000 Calculate the project's expected NPV, its standard deviation, and its coefficient of variation. Round your answers to two decimal places. E(NPV) ONPV S CV - Would you recommend that the project be accepted? -Select-

Answer 1

Formula	Year (n)	0	1	2	3	4	5
	Machine cost (MC)	(260,000)
	Savings (S)		90,000	90,000	90,000	90,000	90,000
	Depreciation rate ('r)		33%	45%	15%	7%	0%
-r*MC	Depreciation (D)		85,800	1,17,000	39,000	18,200	-
S*(1-Tax rate) + (D*Tax rate)	Operating Cash Flow (OCF)		88,320	1,00,800	69,600	61,280	54,000
Increase in NWC is returned at end of project	NWC	(26,000)					26,000
Salvage value*(1-Tax rate)	After-tax salvage value (ATSV)						14,400
MC + OCF + NWC + ATSV	Free Cash Flow (FCF)	(286,000)	88,320	1,00,800	69,600	61,280	94,400
1/(1+d)^n	Discount factor @10%	1.000	0.909	0.826	0.751	0.683	0.621
FCF*Discount factor	PV of FCF	(286,000)	80,290.91	83,305.79	52,291.51	41,855.06	58,614.97
Sum of all PVs	NPV	30,358.24
	Free Cash Flow (FCF)	(286,000)	88,320	1,00,800	69,600	61,280	94,400
FCFn + CFCFn-1	Cumulative Free Cash Flow (CFCF)	(286,000)	(1,97,680)	(96,880)	(27,280)	34,000	1,28,400
3 years + (CFCF in year 3/FCF in year 4)	Paybakc period (in years)					3.45
Using IRR function with FCF	IRR	14.20%
Using MIRR function with FCF; 10% WACC as finance & reinvestment rate	MIRR	12.24%

a). NPV = 30,358.24

IRR = 14.20%; MIRR = 12.24%

Payback period = 3.45 years

b). Using the base case NPV analysis in part (a),

If savings increase by 20%, then savings = 90,000*(1+20%) = 108,000 and NPV = 71,298.74

If savings decrease by 20%, then savings = 90,000*(1-20%) = 72,000 and NPV = -10,582.26

c). Again, using the base case NPV analysis in part (a), the scenario analysis gives the following NPVs:

Scenario	Probability (P)	Cost savings	Salvage value	NOWC	NPV	(P*NPV)	(NPV - E(NPV))^2
Worst case	35%	72,000	19,000	31,000	(14,340.41)	(5,019.14)	1,80,31,67,664.04
Base case	35%	90,000	24,000	26,000	30,358.24	10,625.38	49,94,924.28
Best case	30%	108,000	29,000	21,000	75,056.90	22,517.07	2,20,27,61,606.21
					Total	28,123.31	4,01,09,24,194.52

Expected NPV E(NPV) = sum of all (P*NPV) = 28,123.31

Standard deviation = {[Sum of (NPV - E(NPV)^2]/n}^(1/2)

= (4,010,924,194.52/3)^(1/2) = 36,564.67

Coefficient of Variation (CV) = Standard deviation/E(NPV) = 36,564.67/28,123.31 = 1.30