Question

In: Finance

9. Suppose Blue Thumb Tools is considering the introduction of a new, heavier hammer to be...

9. Suppose Blue Thumb Tools is considering the introduction of a new, heavier hammer to be used for driving spikes. The new hammer will cost $490,000. The cost will be depreciated straight-line to zero over the project’s five-year life, at the end of which the new hammer can be scrapped for $40,000. The new hammer will save the firm $146,000 per year in pretax operating costs, and it required an initial investment in net working capital of $35,000. The tax rate of the firm is 30%.

What are the cash flows of firm’s new project (using a time line)?

What is the net present value of this project (list your setups)?

What is the IRR of this project (list your setups)?

Please solve without excel so that I can see the steps.

Solutions

Expert Solution

Step 1
Calculation of the cash flows of firm’s new project
Year 0 1 2 3 4 5
Investment in a new hammer -$490,000.00
Investment in net working capital -$35,000.00
Savings in pre tax operating cost $146,000.00 $146,000.00 $146,000.00 $146,000.00 $146,000.00
Tax @ 30% on savings in pre tax operating cost -$43,800.00 -$43,800.00 -$43,800.00 -$43,800.00 -$43,800.00
Depreciation Tax shield $29,400.00 $29,400.00 $29,400.00 $29,400.00 $29,400.00
After tax scarp value of new hammer $28,000.00
Cash flows of firm's new project -$525,000.00 $131,600.00 $131,600.00 $131,600.00 $131,600.00 $159,600.00
Step 2
Calculation of the net present value of this project
We are unable to calculate the NPV as the project's required rate of return is not given in the question.
Step 3
Calculation of the IRR of this project
Year Cash flow
0 -      525,000.00
1        131,600.00
2        131,600.00
3        131,600.00
4        131,600.00
5        159,600.00
At Internal rate of return (IRR) , the net present value of project is equal to zero.
We can use the excel formula to calculate the IRR of the project.
IRR of the project =IRR(B15:B20)
IRR of the project 9.36%
Working
Calculation of depreciation tax shield
Depreciation per year on New machine = $490000 / 5 years = $98,000.00
x Tax rate 30%
Depreciation Tax shield per year $29,400.00
Calculation of after tax scarp value of new hammer
Scrap value $40,000.00
Less : Tax @ 30% $12,000.00
After tax scarp value of new hammer $28,000.00

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