Question

Mystic Beverage Company is considering purchasing a new bottling machine. The new machine costs $230,000, plus installation fees of $10,000 and will generate earning before interest and taxes of $60,000 per year over its 6-year life. The machine will be depreciated on a straight-line basis over its 6-year life to an estimated salvage value of 0. Mystic's marginal tax rate is 40%. Mystic will require $50,000 in NWC if the machine is purchased.

(a) determine the initial outlay
(b) determine the annual cash flows in years 1-6
(c) assume the discount rate is 7%, what is the NPV of this project?
(d) What is the IRR of this project
€ should the project be accepted or rejected?

Answer 1

Ans a)		Computation of initial investment
		Cost of machine	230000
	add	installation cost	10000
		Total Cost of machine	240000
	add	working capital	50000
		Total initial investment	290000
		Ans =	-290000
Ans b)	Annual cash flow
		year	1	2	3	4	5	6
	i	EBIT =	60000	60000	60000	60000	60000	60000
	ii	Depreciation = 240000/6	40000	40000	40000	40000	40000	40000
	iii=i-ii	EBT	20000	20000	20000	20000	20000	20000
	iv=iii*40%	Tax @ 40%	8000	8000	8000	8000	8000	8000
	v=iii-iv	Earning after tax	12000	12000	12000	12000	12000	12000
	vi=v+ii	Operating cash flow	52000	52000	52000	52000	52000	52000
	vii	Working capital release						50000
	viii=vii+vi	Net cash flow	52000	52000	52000	52000	52000	102000
Ans c)	Computation of NPV
	year	Cash flow	PVIF @ 7%	present value
	0	-290000	1	(290,000.00)
	1	52000	0.934579439	48,598.13
	2	52000	0.873438728	45,418.81
	3	52000	0.816297877	42,447.49
	4	52000	0.762895212	39,670.55
	5	52000	0.712986179	37,075.28
	6	102000	0.666342224	67,966.91
				(8,822.83)
	NPV =	(8,822.83)
Ans d)	IRR =	6.09%	<< using excel formula>>
Project should not be accepted and should be REJECTED as NPV is negative