Question

In: Finance

15 minutes An industrial organization has bought a specialized machine for $120,000 which will save $20,000...

15 minutes An industrial organization has bought a specialized machine for $120,000 which will save $20,000 each year for 10 years. Straight Line (SL) basis depreciation should be taken into consideration with a depreciable life of 10 years. After tax MARR is 10% per year. Effective income tax rate is 40%. After 10 years, the machine will have zero salvage value. a) Draw a table showing Before Tax Cash Flow (BTCF) and After Tax Cash Flow (ATCF). b) Calculate the after tax PW and IRR. (Use interpolation method to find IRR). Is it feasible?

Expert Solution

Determination of Before Tax cash flows and After Tax cash flows

Year	Cash flow( BTCF)	Depreciation	Taxable income	Tax @ 40%	ATCF ( BTCF - Tax)
0	($120,000)				($120,000)
1	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
2	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
3	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
4	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
5	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
6	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
7	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
8	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
9	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0
10	$20,000	$12,000	$8,000.0	$3,200.0	$16,800.0

Computation of the Present worth.

Year	Cash flow( ATCF)	Disc @ 10%	DCF
0	-$120,000.00	1.0000	-$120,000.00
1	$16,800.00	0.9091	$15,272.73
2	$16,800.00	0.8264	$13,884.30
3	$16,800.00	0.7513	$12,622.09
4	$16,800.00	0.6830	$11,474.63
5	$16,800.00	0.6209	$10,431.48
6	$16,800.00	0.5645	$9,483.16
7	$16,800.00	0.5132	$8,621.06
8	$16,800.00	0.4665	$7,837.32
9	$16,800.00	0.4241	$7,124.84
10	$16,800.00	0.3855	$6,477.13
	Total		-$16,771.27

As the Present worth of the project is Negetive. The Project is not feasible.

Computation of IRR.:

Year	Cash flow( ATCF)	Disc @ 6%	DCF.	Disc @ 7%	DCF
0	-$120,000.00	1.0000	-$120,000.0000	1.0000	-$120,000.000
1	$16,800.00	0.9434	$15,849.0566	0.9346	$15,700.935
2	$16,800.00	0.8900	$14,951.9402	0.8734	$14,673.771
3	$16,800.00	0.8396	$14,105.6040	0.8163	$13,713.804
4	$16,800.00	0.7921	$13,307.1735	0.7629	$12,816.640
5	$16,800.00	0.7473	$12,553.9373	0.7130	$11,978.168
6	$16,800.00	0.7050	$11,843.3371	0.6663	$11,194.549
7	$16,800.00	0.6651	$11,172.9595	0.6227	$10,462.196
8	$16,800.00	0.6274	$10,540.5278	0.5820	$9,777.753
9	$16,800.00	0.5919	$9,943.8942	0.5439	$9,138.087
10	$16,800.00	0.5584	$9,381.0323	0.5083	$8,540.268
	Present Worth		$3,649.4625		-$2,003.830

We know that at IRR, Present value of cash inflows is equal to present value of cash outflow.

So at IRR, Present worth of a projrect should be 0.

From the table, we can observe that , IRR lies between 6% and 7%

By using interpolation technique, we can fin the IRR.

Disc	PW
6%	$3,649.4625
7%.	-$2,003.830

For 1% Change in Disc rate, Present worth turns from $ 3649.4625 to ( $ 2003.830)

So total change in PW= $ 3649.4625-(-$2003.830)

= $5653.2925

Change in Disc	Change in PW
1%	$5,653.29
X %	$3,649.46

X = $ 3649.46/5653.29

X = 0.6455

So the IRR is 6.6455%

Decision: Since the IRR is less than the Cost of Capital ( i.e 10%) the projecct is not feasible.

Hence the project is not feasible under both the criteria(i. e in PW & IRR).

If you are having any doubts,please post a comment.

Thank you.Please rate it.

jeff jeffy answered 1 year ago

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