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You are considering an investment of $500,000 at time zero for machinery and equipment. Annual revenue...

You are considering an investment of $500,000 at time zero for machinery and equipment. Annual revenue produced by the machinery is estimated to be $400,000 with annual operating costs of $140,000. The investment requires an initial investment of $200,000 for working capital at time zero. The working capital return is equal to the initial working capital investment at the end of the project (8th year). Salvage value of the machinery and equipment is expected to be zero. The minimum After Tax Cash Flow ROR (annual discount rate) is 12% and the effective income tax rate is 38%. 1.Calculate the ROR (Internal Rate of Return) for this investment project, assuming straight line depreciation. 2.Calculate the ROR (Internal Rate of Return) for this investment project, assuming declining balance depreciation with a declining rate of 15% per year over 8 years. Note: You will note that at the end of Year 8 the investment cost is not fully depreciated. 3. Calculate the ROR (Internal Rate of Return) for this investment project, using the 5 year MACRS schedule for depreciation (see Example 7-7). Note: There will be zero depreciation in Years 7 and 8 in this problem.

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Expert Solution

St.line depn 0 1 2 3 4 5 6 7 8
1.Initial investment -500000
2.Working capital introd.& recd. -200000 200000
3.Annual revenue 400000 400000 400000 400000 400000 400000 400000 400000
4.Annual Operating costs -140000 -140000 -140000 -140000 -140000 -140000 -140000 -140000
5.Depn.(St.line) -62500 -62500 -62500 -62500 -62500 -62500 -62500 -62500
6. EBT(3+4+5) 197500 197500 197500 197500 197500 197500 197500 197500
7.Tax at 38%(Row 6*38%) -75050 -75050 -75050 -75050 -75050 -75050 -75050 -75050
8. EAT(6+7) 122450 122450 122450 122450 122450 122450 122450 122450
9.Add Back depn.(Row 5) 62500 62500 62500 62500 62500 62500 62500 62500
10.Annual Operating cash flow 184950 184950 184950 184950 184950 184950 184950 184950
11. Net annual cash flows(1+2+10) -700000 184950 184950 184950 184950 184950 184950 184950 384950
12. IRR(of row 11) 22%
NPV calculations:
13. PV F at 12%(1/1.12^no.of yr.) 1 0.89286 0.79719 0.71178 0.63552 0.56743 0.50663 0.45235 0.40388
14. PV at 8%(11*13) -700000 165134 147441 131644 117539 104946 93701 83662 155475
15. NPV(sum of row 14) 299542
Declining balance depn 0 1 2 3 4 5 6 7 8
1.Initial investment -500000
2.Working capital introd.& recd. -200000 200000
3.Annual revenue 400000 400000 400000 400000 400000 400000 400000 400000
4.Annual Operating costs -140000 -140000 -140000 -140000 -140000 -140000 -140000 -140000
5.Depn.(Decl.bal.) -75000 -63750 -54188 -46059 -39150 -33278 -28286 -24043
6. EBT(3+4+5) 185000 196250 205813 213941 220850 226722 231714 235957
7.Tax at 38%(Row 6*38%) -70300 -74575 -78209 -81297 -83923 -86154 -88051.2 -89664
8. EAT(6+7) 114700 121675 127604 132643 136927 140568 143663 146293
9.Add Back depn.(Row 5) 75000 63750 54188 46059 39150 33278 28286 24043
10.Annual Operating cash flow 189700 185425 181791 178703 176077 173846 171949 170336
11. Net annual cash flows(1+2+10) -700000 189700 185425 181791 178703 176077 173846 171949 370336
12. IRR(of row 11) 22%
NPV calculations:
13. PV F at 12%(1/1.12^no.of yr.) 1 0.89286 0.79719 0.71178 0.63552 0.56743 0.50663 0.45235 0.40388
14. PV at 8%(11*13) -700000 169375 147820 129395 113569 99910.9 88076 77781 149573
15. NPV(sum of row 14) 275499
Year Depn.(15%*prev. bal.) Balance
0 500000
1 75000 425000
2 63750 361250
3 54188 307063
4 46059 261003
5 39150 221853
6 33278 188575
7 28286 160289
8 24043 136245
MACRS 0 1 2 3 4 5 6 7 8
1.Initial investment -500000
2.Working capital introd.& recd. -200000 200000
3.Annual revenue 400000 400000 400000 400000 400000 400000 400000 400000
4.Annual Operating costs -140000 -140000 -140000 -140000 -140000 -140000 -140000 -140000
5.Depn.(MACRS) -100000 -160000 -96000 -57600 -57600 -28800 0 0
6. EBT(3+4+5) 160000 100000 164000 202400 202400 231200 260000 260000
7.Tax at 38%(Row 6*38%) -60800 -38000 -62320 -76912 -76912 -87856 -98800 -98800
8. EAT(6+7) 99200 62000 101680 125488 125488 143344 161200 161200
9.Add Back depn.(Row 5) 100000 160000 96000 57600 57600 28800 0 0
10.Annual Operating cash flow 199200 222000 197680 183088 183088 172144 161200 161200
11. Net annual cash flows(1+2+10) -700000 199200 222000 197680 183088 183088 172144 161200 361200
12. IRR(of row 11) 24%
NPV calculations:
13. PV F at 12%(1/1.12^no.of yr.) 1 0.89286 0.79719 0.71178 0.63552 0.56743 0.50663 0.45235 0.40388
14. PV at 8%(11*13) -700000 177857 176977 140705 116356 103889 87214 72919 145883
15. NPV(sum of row 14) 321799
Year MACRS rates % Depn. Amt.
0
1 20 100000
2 32 160000
3 19.2 96000
4 11.52 57600
5 11.52 57600
6 5.76 28800
100 500000

jeff jeffy answered 1 year ago
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