Question

Company Chosen is APPLE

Apple WACC:6.98%

Apple Inc. currently has property and equipment as $37,378,000.00

The firm is looking to expand its operations by 10% of the firm's net property, plant, and equipment. (Calculate this amount by taking 10% of the property, plant, and equipment figure that appears on the firm's balance sheet.)

The estimated life of this new property, plant, and equipment will be 12 years. The salvage value of the equipment will be 5% of the property, plant and equipment's cost.

The annual EBIT for this new project will be 18% of the project's cost. The company will use the straight-line method to depreciate this equipment. Also assume that there will be no increases in net working capital each year. Use 35% as the tax rate in this project. The following capital budgeting results for the project

Net present value

Internal rate of return

Discounted payback period

Should Purchase?

Answer 1

Apple WACC:6.98%

currently has property and equipment as $37,378,000.00

The firm is looking to expand its operations by 10% of the firm's net property, plant, and equipment. (Calculate this amount by taking 10% of the property, plant, and equipment figure that appears on the firm's balance sheet.)

So the Initial Investement in new project = $37,378,000 * 10% = $ 3737800

The estimated life of this new property, plant, and equipment will be 12 years

The salvage value of the equipment will be 5% of the ppe's cost.= 3737800 * 5% = 186890

The annual EBIT for this new project will be 18% of the project's cost. = 3737800 * 18% = 672804

Use 35% as the tax rate

Net present value = $ 660223

Internal rate of return = 10.34%

Discounted payback period = 9.63 years

Should Purchase? Yes, because the company NPV is positive and IRR is higher than WACC(discount rate)

If the a project NPV is positive, we should accept the project and it will add value to the business and increase the wealth of share holders.

Here based on NPV and IRR we shuold purchase it.

1. Initial cash outflow = $ 3737800

2.operating cash flow = $ 546342** same as each year

calculation OCF

EBIT (same year 1 to year 12 ) = 672804

Less Tax expenses @ rate 35% = 672804 * 35% = 235481

Net operating cash flow (excludin deoreciation) = 437323 each year

Depreciation Tax sheild = Dep. Exp * Tax rate = 311483 * 35% = 109019 each year

Each year depreciation (stright line) = 3737800 / 12 = 311483 each year

Net operating cash flow including dep. tax sheild = 437323 + 109019 = 546342**

3. Terminal year cash flow = $ 121479***

Calculation Terminal CF

Book value of asset at the end of 12 th year is zero, because asset fully depreciated

salvage value = 186890

Book value = 0

Taxable gain from sale = 186890

Tax on gain = 186890 * 35% = 65411.5

Net cash inflow from salvage value = 186890 - 65411.5 = 121479***

There is no other cash flow in the end of 12th year

next step to calculate PV of each cash flow using discount rate of 6.98% (WACC)

1. PV initial investment (0th year so this is PV ) =( $ 3737800) outflow

2. PV of operating Cash flow from 1st year to 12th year = 546342 * (1/1+6.98%)^12GT=546342*7.951 = $ 4343965

(inflow)

3. PV of terminal cash inflow = 121479 * (1/1+7.03%)12 = 121479 * 0.445 =$ 54058 (inflow)

NPV = PV of Cash inflow - PV of cash outflow

NPV = (4343965 + 54058) - 3737800 = $ 660223

IRR(internal rate of reture)

IRR is the rate of return at which the pv of cash inflow equal to the pv of cash outflow, in other word IRR is the rate which NPV of project will be zero

For this purpose first we calculate the fake payback period

fake pay back period = initial investment / avg cash flow per year

= 3737800 / 556465.25 = 6.71

After consult the PV of annuty $ 1 table (just look the 12 period row and find apprx. nearest value of 6. 71

i gave here the 12 period row and there discount rate and also i marked the approximate in thetable

Rate	1%	2%	3%	4%	5%	6%	7%	8%	9%	10%	12%
period 12	11.255	10.575	9.954	9.385	8.863	8.384	7.943	7.536	7.161	6.814	6.194

So the apprx. IRR = 10%

for calculatin correct IRR we use trail and error method,for that we take two discount rate

one discount rate is the rate which we get the positive NPV and one is negative NPV. For Positive NPV we can use 6.98% becuase we already calculated, the NPV = $ 660223

and next one we take a discount rate higherthan aprx. IRR, so just take 12% as discount rate and calculate the NPV

NPV @ rate of 12%

1. PV initial investment (0th year so this is PV ) =( $ 3737800) outflow

2. PV of operating Cash flow from 1st year to 12th year = 546342 * (1/1+12%)12GT=546342*6.194 = $ 3384042

(inflow)

3. PV of terminal cash inflow = 121479 * (1/1+12%)12 = 121479 * 0.257=$ 31220 (inflow)

NPV = PV of Cash inflow - PV of cash outflow

NPV = (3384042+ 31220 ) - 3737800 = ( $ 322538 ) NPV as negative

For calculating correct IRR we use the below formula

IRR = Discount rate where NPV is positive + (NPV@ Lower Discount rate / Difference between two NPV) * Higher Dis. rate - Lower Dic. rate

IRR = 6.98% + ($ 660223 / 982761 ) * 12 % - 6.98%

IRR = 6.98% + 0.67 * 5.02%

IRR = 6.98% + 3.36% = 10.34%

Discounted payback period

discounted cash flows(already calculated)

Year 0	1	2	3	4	5	6	7	8	9	10	11	12
3737800	546342	546342	546342	546342	546342	546342	546342	546342	546342	546342	546342	546342 + 121479 = 667821
1	(1/1.0698)1 = 0.935	(1/1.0698)2 = 0.874	(1/1.0698)3 = 0.817	(1/1.0698)4 = 0.763	(1/1.0698)5 = 0.714	(1/1.80698)6 =0.667	(1/1.80698)7 = 0.623	(1/1.0698)8 =0.583	(1/1.80698)9 = 0.545	(1/1.80698)10 = 0.510	(1/1.0698)11 = 0.476	(1/1.0698)12 =0.445
(3737800)	=510830	=477503	=446361	=416859	=390088	=364410	=340371	=318517	=297756	=278634	=260059	=297180
Cumulative CF	(3737800) + 510830 = (3226970)	(2749467)	(2303106)	(1886247)	(1496159)	(1131749)	(791378)	(472861)	(175105)	103529	363588	660768

Here we take 9 . (175105 / 278634) years to recover the initial cost of $ 3737800

9 . (175105 / 278634) years = 9.63 years

Discounted Payback period = 9.63 Years