Question

Holmes Manufacturing is considering a new machine that costs $200,000 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 $27,000 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 10% WACC is appropriate for the project.

A.)Calculate the project's NPV. Round your answer to the nearest cent.
$

Calculate the project's IRR. Round your answer to two decimal places.
%

Calculate the project's MIRR. Round your answer to two decimal places.
%

Calculate the project's payback. Round your answer to two decimal places.
years

B.)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. $

C.)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	$22,000	$29,000
Base case	0.35	90,000	27,000	24,000
Best case	0.30	108,000	32,000	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) = $

?NPV = $

CV =

Would you recommend that the project be accepted? Yes or No

Answer 1

Solution :

First, we need to calculate the cash flow in each year and that is calculated and detailed explanation is provided below:

Particulars	year1	2	3	4	5
Save in cost	90000	90000	90000	90000	90000
Deprecitaion	33 %	45 %	15 %	7 %	0 %
Depreciation expense	66000	90000	30000	14000	0
Increase in operating working capital	24000	24000	24000	24000	24000
profit before tax	0	-24000	36000	52000	66000
Tax rate @40%	0	-9600	14400	20800	26400
Profit after tax	0	-14400	21600	31200	39600
Cash flow = profit +depreciation	66000	75600	51600	45200	39600

Now we will calculate the net present value and the net present value is calculated by discounting the future cash flows at the expected rate.

IRR is the rate of return at which the net present value becomes zero.

Year	Cash flow	Discount rate @10%	Present value
0	-200000	1,00	-             200 000,00
1	66000	0,91	60 000,00
2	75600	0,83	62 479,34
3	5600	0,75	4 207,36
4	45200	0,68	30 872,21
5	39600	0,62	24 588,48
5 Salvage (Machine+working)	51000	0,62	31 666,99
		Net present value	13 814,38

Hence the IRR is the net present value becomes close to zero and the discounted rate at which the net present value becomes zero is 12,65%

Year	Cash flow	Discount rate @12,65%	Present value
0	-200000	1,00	-             200 000,00
1	66000	0,89	58 588,55
2	75600	0,79	59 574,36
3	5600	0,70	3 917,37
4	45200	0,62	28 068,14
5	39600	0,55	21 829,27
5 Salvage (Machine+working)	51000	0,55	28 113,45
		Net present value	91,14

c) The payback period would be :

-200000 +66000+75600+5600+45200 = 7600 at year 4 and hence the payback period is 4.2 years