Question

Company Alex would like to buy a new technological equipment for CZK 16 000 000. Useful life of this equipment is 5 years and expected salvage value is CZK 1 000 000. Company use straight-line method. On the end of 5t? h? year, company will sell this property for CZK 1 500 000. Tax rate is 26 %. Discount rate for evaluation of project effectiveness is 15 %. Expected change of revenues and expenditures during useful life of investment cab be seen in following table:

a) Is it profitable to buy this equipment under such conditions? b) What is the IRR (Internal rate of return) of this investment?

	1.yea r	2.yea r	3.yea r	4.yea r	5.yea r
Revenues (in mil. CZK)	6.5	6.9	7.8	7.8	5.6
Expenditures (in mil. CZK)	1.1	1.2	1.5	1.5	1.7

Answer 1

Annual Deprecitation = (Cost - Salvage value) / Number of years

Annual Deprecitation = (16 000 000 - 1 000 000) / 5

Annual Deprecitation = 3,000,000

Operating cash flow = ( Revenue - Expenditure - depreciation) ( 1 - tax) + depreciation

Operating cash flow for year 1 = ( 6500000 - 1100000 - 3000000) ( 1 - .26) + 3000000

Operating cash flow for year 1 = 4776000

Operating cash flow for year 2 = ( 6900000 - 1200000 - 3000000) ( 1 - .26) + 3000000

Operating cash flow for year 2 = 5052000

Operating cash flow for year 3 = ( 7800000 - 1500000 - 3000000) ( 1 - .26) + 3000000

Operating cash flow for year 3 = 5508000

Operating cash flow for year 4 = ( 7800000 - 1500000 - 3000000) ( 1 - .26) + 3000000

Operating cash flow for year 4 = 5508000

Operating cash flow for year 5 = ( 5600000 - 1700000 - 3000000) ( 1 - .26) + 3000000

Operating cash flow for year 5 = 3666000

Non-operating cash flow at year 5 = 1500000 - 0.26( 1500000 - 0)

Non-operating cash flow at year 5 = 1,110,000.

Total cash flow at year 5 = 3666000 + 1110000

Total cash flow at year 5 = 4776000

To check profiltabilty we calculate NPV:

NPV = -16 000 000 + 4776000 / ( 1 + 0.15) + 5052000 / ( 1 + 0.15)² + 5508000 / ( 1 + 0.15)³ + 5508000 / ( 1 + 0.15)⁴ + 4776000 / ( 1 + 0.15)⁵

NPV = 1,118,413.658

Since it has a positive NPV, it is profitable to buy the equipment.

To calculate IRR, please use a financial calculator:

Keys to use in the financial calculator: CF0 = -16000000, CF1 = 4776000, CF2 = 5052000, CF3 = 5508000, CF4 = 5508000, CF5 = 4776000 IRR CPT

When you click CPT, you get IRR as 17.88%