Question

Read Book Company is the manufacturer of of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses of $300,000. An inventory investment of $75,000 is required during the life of the project. Read Book Company is in the 25 percent tax bracket, and its existing cost of capital is 8 percent

a. Calculate the initial outlay of the project

b. Calculate the annual after-tax operating cash flow for Years 1-4.

c. Determine the terminal year non-operating cash flow in year 4.

d. What is the equipment NPV?

e. What the estimated Internal Rate of Return (IRR) of the equipment

f. Should the equipment be accepted based on the IRR criterion?

Answer 1

Question a)

Initial outlay for the project

i. Capex - $ 850,000

ii. Insallation - $ 280,000

iii. Working Capital req - $ 75,000

Total Outlay- $ 1,205,000

Question b)

The Excel model below provide after tax annual operating cash flow

Question C

Terminal year non-operating cash flow is the salvage value of the equipment = $350,000

Question D , E, F (Excel Model provided below)

D) Equipment NPV = $-33,402

E) IRR = 6.8%

F) Since IRR 6.8% is less than cost of capital 8%, the project should not be accepted