Question
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You are evaluating a small project for your company. The idea is to introduce a new,...
- You are evaluating a small project for your company. The idea is to introduce a new, but short lived, new product. Sales over the 6 year useful life of the project will be 100,000 units, 120,000 units, 110,000 units, 100,000 units, 70,000 units and 70,000 in each of the 6 years. The price will fluctuate each year, with the pattern being $16, $18, $17, $14, $14 and $14. The cash operating expenses will be, on a per unit basis, $7, $8, $10, $8, $7 and $7. The project will require two pieces of equipment. The Loader will cost $500,000 installed, and the Stamper will cost $1,000,000 installed. Both will be depreciated using straight line depreciation over the 6 year useful life of the project. At the end of the project’s useful life, the Loader will be sold for $100,000 and the Stamper will be sold for $200,000. In addition, an investment in NWC will be required initially at a cost of $250,000, and at the end of the project’s life this investment will be returned. The tax rate is 40%, and your cost of capital is 13%. What is the IRR for the project? What is the MIRR for the project? Should the project be accepted? Assume that your worst case analysis is that all prices are $1 lower than your base case analysis. Does this change the IRR estimate? Is the project still acceptable?
Solutions
Expert Solution
| Initial Investment | |
| Loader | $ -5,00,000.00 |
| Stamper | $ -10,00,000.00 |
| NWC | $ -2,50,000.00 |
| Total Investment | $ -17,50,000.00 |
| Cost of Capital | 13% |
| Depreciation Schedule Calculation | |||
| Loader | Stamper | ||
| Original Value | $ 5,00,000.00 | $ 10,00,000.00 | A |
| Salvage Value (after 6 years) | $ 1,00,000.00 | $ 2,00,000.00 | B |
| Amount to be Depreciated over 6 years | $ 4,00,000.00 | $ 8,00,000.00 | C = A - B |
| Annual Depreciation (straight Line Method) | $ 66,666.67 | $ 1,33,333.33 | D = C/6 |
| Total Depreciation for Project | $ 2,00,000.00 | ||
In straight line method, Annual Depreciation is obtained by diving total depreciation amount by number of years (i.e. 6 here)
| Proforma Income Statement for the Project | ||||||||
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | ||
| Price/Unit | $ 16.00 | $ 18.00 | $ 17.00 | $ 14.00 | $ 14.00 | $ 14.00 | a | |
| Cost/Unit | $ 7.00 | $ 8.00 | $ 10.00 | $ 8.00 | $ 7.00 | $ 7.00 | b | |
| Sales in Units | 100000 | 120000 | 110000 | 100000 | 70000 | 70000 | c | |
| Sales | $ 16,00,000.00 | $ 21,60,000.00 | $ 18,70,000.00 | $ 14,00,000.00 | $ 9,80,000.00 | $ 9,80,000.00 | d=a*c | |
| COGS | $ 7,00,000.00 | $ 9,60,000.00 | $ 11,00,000.00 | $ 8,00,000.00 | $ 4,90,000.00 | $ 4,90,000.00 | e=b*c | |
| Contribution Margin | $ 9,00,000.00 | $ 12,00,000.00 | $ 7,70,000.00 | $ 6,00,000.00 | $ 4,90,000.00 | $ 4,90,000.00 | f=d-e | |
| Depreciation | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | g | |
| Profit Before tax (PBT) | $ 7,00,000.00 | $ 10,00,000.00 | $ 5,70,000.00 | $ 4,00,000.00 | $ 2,90,000.00 | $ 2,90,000.00 | h=f-g | |
| Tax @ 40% | $ 2,80,000.00 | $ 4,00,000.00 | $ 2,28,000.00 | $ 1,60,000.00 | $ 1,16,000.00 | $ 1,16,000.00 | i=0.40*h | |
| Profit After Tax (PAT) | $ 4,20,000.00 | $ 6,00,000.00 | $ 3,42,000.00 | $ 2,40,000.00 | $ 1,74,000.00 | $ 1,74,000.00 | j=h-i | |
| Depreciation | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | g | |
| Cash Flow from Project | $ 6,20,000.00 | $ 8,00,000.00 | $ 5,42,000.00 | $ 4,40,000.00 | $ 3,74,000.00 | $ 3,74,000.00 | k=j+g | |
| Salvage Value of Loader | $ 1,00,000.00 | l | ||||||
| Salvage Value of Stamper | $ 2,00,000.00 | m | ||||||
| Return investment | $ 2,50,000.00 | n | ||||||
| Total Cash flows from the Project | $ -17,50,000.00 | $ 6,20,000.00 | $ 8,00,000.00 | $ 5,42,000.00 | $ 4,40,000.00 | $ 3,74,000.00 | $ 9,24,000.00 | o=k+l+m+n |
| IRR | 27.04% | |||||||
All of the rest can be calculated manually, But IRR is a trial and error method manually. Hence, using excel IRR function, IRR can be calculated and it comes out to be 27.04%.
With IRR 27.04% which is greater than cost of Capital 13%, project can be taken.
For MIRR, since financing cost is not given separately and there is no other negative cashflow it can be calculated simply by using following formula:
FV of positive cashflow using cost of capital = $58,34,372.74
n=6
MIRR = 22.22%
For Worst Case,
Just by reducing prices by $1
| Proforma Income Statement for the Project | ||||||||
| Year 0 | Year1 | Year 2 | Year3 | Year4 | Year5 | Year6 | ||
| 1 | 2 | 3 | 4 | 5 | 6 | |||
| Price/Unit | $ 15.00 | $ 17.00 | $ 16.00 | $ 13.00 | $ 13.00 | $ 13.00 | a | |
| Cost/Unit | $ 7.00 | $ 8.00 | $ 10.00 | $ 8.00 | $ 7.00 | $ 7.00 | b | |
| Sales in Units | 100000 | 120000 | 110000 | 100000 | 70000 | 70000 | c | |
| Sales | $ 15,00,000.00 | $ 20,40,000.00 | $ 17,60,000.00 | $ 13,00,000.00 | $ 9,10,000.00 | $ 9,10,000.00 | d=a*c | |
| COGS | $ 7,00,000.00 | $ 9,60,000.00 | $ 11,00,000.00 | $ 8,00,000.00 | $ 4,90,000.00 | $ 4,90,000.00 | e=b*c | |
| Contribution Margin | $ 8,00,000.00 | $ 10,80,000.00 | $ 6,60,000.00 | $ 5,00,000.00 | $ 4,20,000.00 | $ 4,20,000.00 | f=d-e | |
| Depereciation | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | g | |
| Profit Before tax (PBT) | $ 6,00,000.00 | $ 8,80,000.00 | $ 4,60,000.00 | $ 3,00,000.00 | $ 2,20,000.00 | $ 2,20,000.00 | h=f-g | |
| Tax @ 40% | $ 2,40,000.00 | $ 3,52,000.00 | $ 1,84,000.00 | $ 1,20,000.00 | $ 88,000.00 | $ 88,000.00 | i=0.40*h | |
| Profit After Tax (PAT) | $ 3,60,000.00 | $ 5,28,000.00 | $ 2,76,000.00 | $ 1,80,000.00 | $ 1,32,000.00 | $ 1,32,000.00 | j=h-i | |
| Depreciation | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | g | |
| Cash Flow from Project | $ 5,60,000.00 | $ 7,28,000.00 | $ 4,76,000.00 | $ 3,80,000.00 | $ 3,32,000.00 | $ 3,32,000.00 | k=j+g | |
| Salvage Value of Loader | $ 1,00,000.00 | l | ||||||
| Salvage Value of Stamper | $ 2,00,000.00 | m | ||||||
| Return investment | $ 2,50,000.00 | n | ||||||
| Total Cashflows from the Project | $ -17,50,000.00 | $ 5,60,000.00 | $ 7,28,000.00 | $ 4,76,000.00 | $ 3,80,000.00 | $ 3,32,000.00 | $ 8,82,000.00 | o=k+l+m+n |
| IRR | 22.53% | |||||||
Even with worst case scenario IRR is much above cost of capital of 13%. Go for the Project
And using the method same as above
MIRR = 20.35%
jeff jeffy answered 1 year agoRelated Solutions
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