Question

Read Book Company is the manufacturer 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 $280,000 is 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.

Initial outlay = -$1,130,000

Annual cash flow = Year 1 = 319,157 year 2 = 350,571 year 3 = 266,838    year 4 = 245,933

Terminal non operating cash flow = $337,500

NPV = $31,739.98

a. What is the estimated Internal Rate of Return (IRR) of the equipment?   

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

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Answer 1

a. The estimated Internal Rate of Return (IRR) of the equipment is 9.09%.

b.The Project should be accepted when the IRR of the project is more than the cost of capital.In the given case the project has the IRR of 9.09% which is higher than its existing cast of capital of 8 % ,therefore the project should be accepted.

Detailed calculation is shown in the sheet uploaded below:-->