Question

Holmes Manufacturing is considering a new machine that costs $250,000 and would reduce
pre-tax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS
method to depreciate the machine, and management thinks the machine would have a value
of $25,000 at the end of its 5-year operating life. The applicable depreciation rates are 33%,
45%, 15%, and 7%. Net operating working capital would increase by $25,000 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 13% WACC is appropriate for the project.
a. Calculate the project's NPV. Round your answer to the nearest cent.
b. Calculate the project's IRR. Round your answer to two decimal places.

Answer 1

First we need to compute the cash flows

For year 0 The initial investment would be $250,000 + the working capital increase of $25,000 =$275,000

the depreciation base would be $250,000 So year 1 depreciation82,500($250,000*.33) year 2 $112,500($250,000*.45) year 3 $37,500(250,000*.15) year 4 17,500 (250,000*.07)

Fro year 1 $90,000-82,500($250,000*.33)=7,500 less tax @ 40% =4,500 add back depreciation $82,500 we get $87,000

For year 2 $90,000-$112,500=-22,500 add tax refund @40% we get -13,500 add back tax depreciation $112,500 we get $99,000

For year 3 $90,000-$37,500=52,500 Less tax @40%=31,500 add back tax depreciation 37,500 we get $69,000

For year 4 $90,000-$17,500=72,500 less tax @ 40% = 43,500 add back tax depreciation 17,500 e get $61,000

For year 5 $90,000 less tax @40%=$54,000 add after tax salvage value (25,000*.6=15,000) we get 69,000 add back working capital recovered 25,000 we get cash flow as $94,000

a.Now using excel we can compute the NPV

The discount rate is given as 13%

The NPV can be computed using the formula =NPV(13%,B3:B7)+B2 we get NPV as $15,775.01

b.The IRR can be computed using the formula =IRR(B2:B7) as 15.39%