Question

Shirley industries is analyzing an average risk project, and the following data has been developed. Annual unit sales will be constant but the sales price will increase with inflation which is to be 5%. Fixed costs will also be constant but variable costs will rise with inflation. The project involved buying a $100,000 piece of equipment that will last for 3 years and be straight lined depreciated to zero. At the end of of the project there will be a $14,500 after tax salvage value . this is just one project for the firm so any losses can be used to offset gains on other projects. Wat is the 1 year operating cash flow? What is the 2 year depreciation expense? What is the 3 year total cash flow? What is the projects IRR, using a 10% WACC. Lastly would you recommend Shirley accept of reject the project?

WACC…. 10%

Net investment cost( depreciable basis…$100,000

Units sold a year… $40,000

Average price per unit…$25.00

Fixed op.cost excl depreciation (constant)…$150,000

Variable op. cost/unit year 1…33.33%

Tax rate… 40%

After tax salvage value…$14,500

Question

Year 1 OCF?

Year 2 depreciation?

Year 3 total CF?

IRR

Accept of reject?

Answer 1

Operating cost for each year and NPV and IRR is calculated in excel and screen shot provided below:

Year 1 OCF is $348,667.

Year 2 depreciation is $33,333.33.

Year 3 total CF is 404,167.

IRR of project is 350.43%.

Since, IRR of project is more than WACC of project, so project should be accepted.