Question

Holmes Manufacturing is considering a new machine that costs $230,000 and would reduce pretax 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 $26,000 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 $24,000 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 12% WACC is appropriate for the project.

1. 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. $

2. 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	$21,000	$29,000
   Base case	0.35	90,000	26,000	24,000
   Best case	0.30	108,000	31,000	19,000

   Calculate the project's expected NPV, its standard deviation, and its coefficient of variation. Round your answers to two decimal places.

   E(NPV) = $

   σ_NPV = $

   CV =

please help!Thank you!

Answer 1

Base case
a..Cost savings	90000
Year	0	1	2	3	4	5
1.Initial cost	-230000
2.NC introd.& recove.	-24000					24000
3.After-tax cost savings(90000*(1-40%))		54000	54000	54000	54000	54000
4.Depn. Tax shields(230000*dep.%*40%)		30360	41400	13800	6440
5.After-tax salvage(26000*(1-40%)						15600
6.Total annual FCFs(1+2+3+4+5)	-254000	84360	95400	67800	60440	93600
7. PV F at 12%(1/1.12^Yr.n)	1	0.89286	0.79719	0.71178	0.63552	0.56743
8.PV at 12%(6*7)	-254000	75321.43	76052.30	48258.70	38410.71	53111.15
9.NPV(sum of row 8)	37154.29

Changing values for cost savings in the above table,following values of NPVs are obtained

ANSWER:a	Cost savings	NPV
20% savings increase. $	90000*(1+20%)= 108000	76086
20% savings decrease. $	90000*(1-20%)=72000	-1777

Worst case
b .Cost savings	72000	Cost Savings	Salvage Value	NOWC
		$72,000	$21,000	$29,000
Year	0	1	2	3	4	5
1.Initial cost	-230000
2.NC introd.& recove.	-29000					29000
3.After-tax cost savings(90000*(1-40%))		43200	43200	43200	43200	43200
4.Depn. Tax shields(230000*dep.%*40%)		30360	41400	13800	6440
5.After-tax salvage(21000*(1-40%)						12600
6.Total annual FCFs(1+2+3+4+5)	-259000	73560	84600	57000	49640	84800
7. PV F at 12%(1/1.12^Yr.n)	1	0.89286	0.79719	0.71178	0.63552	0.56743
8.PV at 12%(6*7)	-259000	65678.57	67442.60	40571.47	31547.12	48117.80
9.NPV(sum of row 8)	-5642.44

BEST Case		Cost Savings	Salvage Value	NOWC
b.3Cost savings	108000	108,000	31,000	19,000
Year	0	1	2	3	4	5
1.Initial cost	-230000
2.NC introd.& recove.	-19000					19000
3.After-tax cost savings(90000*(1-40%))		64800	64800	64800	64800	64800
4.Depn. Tax shields(230000*dep.%*40%)		30360	41400	13800	6440
5.After-tax salvage(31000*(1-40%)						18600
6.Total annual FCFs(1+2+3+4+5)	-249000	95160	106200	78600	71240	102400
7. PV F at 12%(1/1.12^Yr.n)	1	0.89286	0.79719	0.71178	0.63552	0.56743
8.PV at 12%(6*7)	-249000	84964.29	84661.99	55945.93	45274.31	58104.51
9.NPV(sum of row 8)	79951.02

Summary
Scenario	Prob.	NPV
Worst case	35%	-5642.44
Base case	35%	37154.29
Best Case	20%	79951.02

Project's Expected NPV= Sum of (Probablities*NPV at that prob.)

ie. (35%-5642.44)+(35%*37154.29)+(20%*79951.02)=

23352.12

Std. deviation = Sq,rt. Of ( sum of prob.*squared deviations from the expected Std. dev.)

ie.Sq. rt.of ((-5642.44-23352.12)^2*35%)+((37154.29-23352.12)^2*35%)+((79951.02-23352.12)^2*20%)=

(((-5642.44-23352.12)^2*35%)+((37154.29-23352.12)^2*35%)+((79951.02-23352.12)^2*20%))^(1/2)=

31648.09

Coefficient of variation=

Std. devn/Expected NPV

ie. 31648.09/23352.12=

1.36