Question
In: Finance
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.
Solutions
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 |
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