Question

Alset Inc. hires you as a consultant, manufacturers of fine personalized drone. The market for

drones is growing quickly. The firm purchased some land three years ago for $1.44 million

expecting to use it as a toxic waste dump site. Few months ago Alset Inc. hired another firm to

dispose of all toxic materials. Based on a recent appraisal, the firm believes the current market

value of the land for $1.54 million on an after-tax basis. In four years, the land could be sold for

$1.64 million after taxes. The land will be utilized for the project.

The firm also hired a marketing firm to analyze the personalized drone market, at a cost of

$129,000. An excerpt of the marketing report is as follows:

The flying car industry will have a rapid expansion in the next four years. With the brand name

recognition that Alset brings to bear, we feel that the company will be able to sell 4,200, 5,100,

5,700, and 4,600 units each year for the next four years, respectively. Again, capitalizing on the

name recognition of Alset, we feel that a premium price of $690 can be charged for each

personalized drone. Because these drones appear to be a fad, we feel at the end of the four-year

period, sales should be discontinued.

Alset believes that fixed costs for the project will be $445,000 per year, and variable costs are 10

percent of sales. The equipment necessary for production will cost $3.9 million and will be

depreciated according to a three-year MACRS schedule. At the end of the project, the equipment

can be scrapped for $420,000. Net working capital of $129,000 will be required immediately.

Alset has a 40 percent tax rate, and the required return on the project is 14 percent.

Three year MACRS Schedule

Recovery Year

3-Year

1. 33.33%

2. 44.45%

3. 14.81%

4. 7.41%

1. What is the NPV of the project? Based on the NPV would you accept or reject this project?

2. What is the IRR of the project? Based on the IRR would you accept or reject this project?

3. What is the discounted payback? Based on the discounted payback would you accept or reject

this project?

Answer 1

year	0	1	2	3	4
cost of equipment	-3900000
investment in working capital	-129000
Units to be sold		4200	5100	5700	4600
price		690	690	690	690
expected sales		2898000	3519000	3933000	3174000
variable cost-10% of sales		289800	351900	393300	317400
less fixed cost		445000	445000	445000	445000
annual depreciation = cost of machine*MACRS rate		1299870	1733550	577590	288990
operating profit		863330	988550	2517110	2122610
after tax profit=operating profit*(1-tax rate)		517998	593130	1510266	1273566
add annual depreciation		1299870	1733550	577590	288990
recovery of working capital					129000
after tax sale proceed of equipment =420000*(1-.4)					252000
net operating cash flow	-4029000	1817868	2326680	2087856	1943556
present value factor =1/(1+r)^n r = 14%	1	0.877192982	0.769467528	0.674971516	0.592080277
present value of net operating cash flow =net operating cash flow*present value factor	-4029000	1594621.053	1790304.709	1409243.33	1150741.176
Net present value =sum of present value of cashf low	1915910.27
IRR =Using IRR function in MS excel	IRR(C4756:G4756)	35%
year	0	1	2	3	4
present value of net operating cash flow =net operating cash flow*present value factor	-4029000	1594621.053	1790304.709	1409243.33	1150741.176
cumulative cash flow		1594621.053	3384925.762	515074.2382
				amount to be recovered in year 3
payback period = year before final year of recovery+(amount to be recovered in final year of recovery/cash flow of final year of recovery)	2+(515074.23/1409243.33)	2.37
Using all the three method NPV,IRR and discounted payback period, project would be accepted as NPV is positive, IRR Is more than the required rate of return of 14% and discounted payback period is less the life of project.