Question

CheapO is evaluating the purchase of a new crane system for $1,000,000. If they purchase this system, revenues will increase by $250,000 and associated expenses will increase by 65% of revenues. The installation of the system is expected to cost $100,000 and require training of another $25,000. Because of the increase in business expected by the purchase of the system Accounts Receivable is expected to increase by $30,000. The company expects to use this machine for 10 years after which it will have no salvage value. Assume simplified straight-line depreciation and that this machine has been depreciated down to zero, a 35% marginal tax rate, and a required rate of return of the WACC you previously calculated. WACC = 6.53% What is the initial outlay associated with this project? What are the annual after-tax cash flows associated with this project for years 1 through 9? What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with termination of the project)? What is the project’s NPR and IRR?

Answer 1

WACC = 6.53% and Tax rate =35%

NPV of Cash Flow

$ 392,408

Calculated below.

Net Cash Flow
	Y0	1	2	3	4	5	6	7	8	9	10
Net Capital Costs
New equipment cost	$        1,000,000
Equipment ship & install cost and Training cost	$           125,000
	$                   -
		$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -
Total Capital	$       (1,125,000)	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -	$                 -
Operating and Maintenance Costs
Operating Cost		$         162,500	$         162,500	$         162,500	$         162,500	$         162,500	$         162,500	$         162,500	$         162,500	$         162,500	$         162,500
Fixed cost		$                 -	$                 -	$                 -	$                 -	$                 -
Escalation of Costs
Total Costs	$                   -	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)
Revenue and Operating Benefits
Sales		$         250,000	$         250,000	$         250,000	$         250,000	$         250,000	$         250,000	$         250,000	$         250,000	$         250,000	$         250,000
Benefit 1
Benefit 2
Escalation of Benefits ( account recievables)		$           30,000	$           30,000	$           30,000	$           30,000	$           30,000	$           30,000	$           30,000	$           30,000	$           30,000	$           30,000
Total Benefits and Revenue	$                   -	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000
Cash Flow Before Taxes	$       (1,125,000)	$         117,500	$         117,500	$         117,500	$         117,500	$         117,500	$         117,500	$         117,500	$         117,500	$         117,500	$         117,500
Income Tax Calculation
Depreciation Expense		$        (100,000)	$        (100,000)	$        (100,000)	$        (100,000)	$        (100,000)	$        (100,000)	$        (100,000)	$        (100,000)	$        (100,000)	$        (100,000)
Operating Cost		$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)	$        (162,500)
Operating Benefits		$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000	$         280,000
Net Income Taxes	$                   -	$            6,125	$            6,125	$            6,125	$            6,125	$            6,125	$            6,125	$            6,125	$            6,125	$            6,125	$            6,125
Cash Flow After Taxes	$       (1,125,000)	$         223,625	$         223,625	$         223,625	$         223,625	$         223,625	$         123,625	$         123,625	$         123,625	$         123,625	$         123,625
Discounted Cash Flow (After Tax)	$       (1,125,000)	$         209,917	$         197,050	$         184,971	$         173,633	$         162,990	$           84,581	$           79,397	$           74,530	$           69,961	$           65,673

NPV = $ 392408

IRR = 13.49%

Annual after tax income = 2,11,375