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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