Question

A company is considering a new project. This project will require the purchase of $321,000 of equipment, the purchase of $45,000 in inventory and will increase accounts payable by $73,000. Expected sales are $625,000 with costs of $480,000. The project will last for five years, be taxed at 35% and have a required rate of return of 14%. The equipment will have no salvage value at the end of the project and will be depreciated using the MACRS three-year class. The increase in inventory and accounts payable will revert back to normal at the ends of the project’s life. [When necessary, please carry one decimal in your calculations]

6- What is the annual cash flow for year 1 of the project?

A)$66,250

B)$88,720

C)$110,900

D)$116,720

E)$131,696

7- What is the annual cash flow for year 3 of the project?

A)$66,250

B)$88,720

C)$110,900

D)$116,720

E)$131,696

8- What is the total cash flow for year 5 of the project?

A)$66,250

B)$88,720

C)$110,900

D)$116,720

E)$131,696

9- What is the net present value (NPV) of this project?

A)$93,167

B)$103,459

C)$144,178

D)$78,056

E)$107,709

10- What is the internal rate of return (IRR) of this project?

A)22%

B)25%

C)30%

D)33%

E)27%

Answer 1

Calculation of Depreciation

Depreciation Rate	Depreciation (Cost * Depreciation Rate)
33.33%	106989
44.45%	142685
14.81%	47540
7.41%	23786

Initial Investment = Cost + Inventory - Accounts Payable = $321,000 - $45,000 + $73,000 = $293,000

Schedule - Calculation of Annual Cash flow and NPV of the project

	Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
	Sales	6,25,000	6,25,000	6,25,000	6,25,000	6,25,000
Less:	Costs	(4,80,000)	(4,80,000)	(4,80,000)	(4,80,000)	(4,80,000)
Add:	Depreciation	(1,06,989)	(1,42,685)	(47,540)	(23,786)	-
	Savings after cost and depreciation	38,011	2,316	97,460	1,21,214	1,45,000
Less:	Tax @ 35%	(13,304)	(810)	(34,111)	(42,425)	(50,750)
	Savings after tax	24,707	1,505	63,349	78,789	94,250
Add:	Depreciation	1,06,989	1,42,685	47,540	23,786	-
Add:	Working Capital recovered	-	-	-	-	(28,000)
	Annual Cash Flow	1,31,696	1,44,190	1,10,889	1,02,575	66,250
	PVF @ 14%	0.87719298	0.76946753	0.67497152	0.59208028	0.51936866
	P.V. of net cash flow	1,15,523	1,10,949	74,847	60,733	34,408
	Total P.V. of net cash flow	3,96,460
	Initial investment	(2,93,000)
	NPV	1,03,460

From above Schedule:

Question	Answer option	$
6	E	1,31,696
7	C	1,10,889
8	A	66,250
9	B	1,03,460

Answer - 10

By hit and trial method, I assume Required return is 30%

Now IRR is the rate of return where NPV is 0

Calculation of NPV when r = 30%

Year	Cashflow	PVF @ 30%	P.V.
0	(2,93,000.00)	1	(2,93,000)
1	1,31,696.26	0.7692308	1,01,305
2	1,44,189.58	0.591716	85,319
3	1,10,889.04	0.4551661	50,473
4	1,02,575.14	0.3501278	35,914
5	66,250.00	0.2693291	17,843
		NPV	(2,146)

NPV IS not coming out to 0 because of rounding of rate if we take rate = 29.58% then NPV will come out as 0.

So Out of option, the appropriate answer is 30% i.e. option C