Question

William's Investment $2,100 in machinery, which has a useful life of 3 years and will be depreciated according to a straight-line depreciation method towards a salvage value of $0. At the end of its useful life, the equipment will be sold for $100. Aside from the machinery, the project requires an initial investment of $1,000 in net working capital, half of which will be recovered at the end of the project’s life. To assess the impact of the new project, the company conducted a feasibility study one year ago. The study cost $50. According to the study, the new project will decrease after-tax income from existing products by $100 per year, starting in year 1. Finally, your accountant, who has been working with the company for 5 years, pointed out that if the project is not accepted, the company could rent out its facilities for $150 per year, starting in year 1. The accountant’s salary is $100 per year and will increase to $110 if the project is accepted because she will have to work overtime on the new project. Project payoffs occur at the end of the year, the discount rate is 15%, and the tax rate is 30%. Other details for the project are provided below:

Year	Year 1	Year 2	Year 3
Revenues	2,000	2,000	2,000
Production costs	700	700	700

i) Compute the NPV of the project in two different ways: 1) using the built-in Excel function and 2) by discounting the cashflows

ii) Compute the PI of the project

iii) Compute the IRR of the project and write down the NPV equation that is solved by the IRR

iv) Using the IRR as the discount rate, re-calculate the NPV of the project using the buil-in Excel function. What is the NPV of the project if the IRR is used as the discount rate?

v) Can we use the IRR to assess the profitability of this project? Why?

vi) Should the project be accepted?

Answer 1

Based on the given data, pls find the below workings, steps and excel formulae as mentioned in the excel screenshot; Answers as below:

i) Compute the NPV of the project in two different ways: 1) using the built-in Excel function and 2) by discounting the cashflows NPV is worked out using discounting method as well as using excel inbuilt formula and is - $ 700.93 and hence this project is not feasible.

ii) Compute the PI of the project PI is -22.6% and hence this project is not feasible.

iii) Compute the IRR of the project and write down the NPV equation that is solved by the IRR

IRR of this project is 2.6% and hence this project is not feasible, as the same is much lower than that of the required return (discounting factor).

iv) Using the IRR as the discount rate, re-calculate the NPV of the project using the buil-in Excel function. What is the NPV of the project if the IRR is used as the discount rate? IRR or the Internal Rate of Return is the Return expected to derive from the Projected cash flows of the invesment. At this IRR rate the NPV of the discounted cash flows shall be Zero.

v) Can we use the IRR to assess the profitability of this project? Why? The IRR is the Internal Rate of Return which can be expected from the given cash flows and is the profitability one can expect from this project, to the maximum. IRR calculates the maximum potential of the return expected from the given range of expected cash flows.

vi) Should the project be accepted? No; This project is not feasible for recommedation for invesment as the NPV is negative.

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;