Question

White Waters Inc. plans a 4-year capital investment project, where it requires an asset that costs $160,000. The asset will be depreciated using the 3-year MACRS (use these schedule: 33%, 44%, 14%, and 7% for years 1 to 4, respectively). The company expects that the asset will be worth $30,000 at the end of the project. Incremental sales are expected to be $90,000, $120,000, $130,000 and $150,000 for year 1 to 4, respectively. Corresponding variable expenses are expected to be 40% of the sales, and the fixed costs are $25,000 a year. The company will need to invest $14,000 at time-0 in net working capital, which will increase $1,000 each year. The cost of capital is 14% and the corporate tax rate is 30%, white waters will have to use a building that it bought 15 years ago for $150,000. This building could generate lease income of $20,000 a year if the project is not undertaken. It also spent $80,000 in R&D to develop the new product for this project. To partly finance the project, the company plans to borrow $100,000 at a 10% interest rate for the duration of the project. Develop the cash flows for the project. What are its NPV, IRR, and MIRR? Interpret the results in your own words. For grading details, please see the associated rubric. ***Use Word. You must show your work.

Answer 1

Assumption / Note

I) Building built 15 years ago for 150000 is not relevant since it is sunk cost

ii) 10% interest rate on borrowing of 100000 is not relevant since financial cost is not included in project cashflow

iii) Opportunity cost of loosing 20000 / year rent from building must be included for oportunity cost

iV) R&D cost is taken at CAPEX since, it is done for this project only.

v) For NPV , NPV function is used, IRR of excel function used with cost of capital 14%

vI) Net working capital (NWC) is recovered at the end of project life.

Vi) For MIRR, all casflows are future valued at t=4, which is 139064 = 254000 x ( 1 + MIRR )^{4 ; MIRR = 13.98 %}

^{Detailed Calculation:}

	Year0	Year1	Year2	Year3	Year4
Sales		90,000	1,20,000	1,30,000	1,50,000
Variable Expenses ( 40 % of Sales)		36,000	48,000	52,000	60,000
Fixed Cost		25,000	25,000	25,000	25,000
EBDITA		29,000	47,000	53,000	65,000
(-) Depriciation		52,800	72,000	24,000	11,200
EBIT		-23,800	-25,000	29,000	53,800
Tax @ 30 %		-	-	8,700	16,140
1) Operating Cash Flow
EBIT		-23,800	-25,000	29,000	53,800
+Depriciation		52,800	72,000	24,000	11,200
-Tax		-	-	8,700	16,140
Opearting Cash Flow		29,000	47,000	44,300	48,860
2) Net Working Capital
Initial NWC	-14000
Change in NWC		-1,000	-1,000	-1,000	-1,000
NWC Recovery					18,000
Total change in NWC	-14000	-1000	-1000	-1000	17000
3. Capital Spending
Initial Out Lay	-160000
R&D Cost	-80000
After Tax Salvege					21,000
Capital Spending	-240000	0	0	0	21000
Total Project Cash Flow	-2,54,000	28,000	46,000	43,300	86,860
(-)Effect of Opportunity Cost	-	-20,000	-20,000	-20,000	-20,000
Total Free Cashflow of Project	-2,54,000	8,000	26,000	23,300	66,860
Cost of Capital	14%
NPV	$      -1,71,662.98
IRR	-20%
FV of All Positive Cash flow at t =4					1,39,064
MIRR	-13.98%