Question

X Company is considering a new processor that costs $150,000. Shipping and setup costs for the new processor are estimated to be $15,000. X’s working capital requirement is expected to increase by $17,000 when the new processor begins operation and is expected to be fully recoverable at the end of the project. The new processor’s useful life is expected to be 5 years and its salvage value at that point is estimated to be $60,000. The new processor is being depreciated using a 5-year ACRS life. Assume a tax rate of 35% and a cost of capital of 12%.

Estimated incremental revenues and incremental cash operating expenses for the new processor before tax for each year are shown in the table below.

Q1. What is the cost of the initial outlay?

Q2. Given the initial outlay for the new processor, assume the following yearly incremental after-tax cash flows (below) . Assume a cost of capital of 12%. What is the NPV of the Project?

Year 1	$40,000
Year 2	$40,000
Year 3	$50,000
Year 4	$55,000
Year 5	$100,000

Q3. Given the initial outlay for the new processor, assume the following yearly incremental cash flows (below). Assume a cost of capital of 12%. What is the IRR of the Project?

Year 1	$45,000
Year 2	$45,000
Year 3	$50,000
Year 4	$50,000
Year 5	$105,000

Answer 1

Q - 1

the cost of the initial outlay = Cost of the new processor + shipping & set up cost + working capital investment = 150,000 + 15,000 + 17,000 = $ 182,000

Q - 2

Capitalized cost = 150,000 + 15,000 = 165,000

Depreciation rate for year 6 under 5 years MACRS schedule = 5.76%

Hence, book value after year 5 = 165,000 x 5.76% =  9,504.00

Salvage value = 60,000

Hence, gain on sale = Salvage value - book value = 60,000 -  9,504.00 =  50,496

Tax on gain = Gain x Tax rate =  50,496 x 35% =  17,673.60

Hence, the post tax salvage value = Sale value - tax = 60,000 -  17,673.60 =  42,326.40

Please see the table below. All financials are in $. Please see the second row / column to understand the mathematics. The last row colored in yellow contains your answer. Adjacent cell in blue shows the excel formula used to get the answer.

Q - 3