Question

1.A firm is thinking about launching a new product. The initial investment in equipment is $600,000. The project has an estimated life of five years. The revenue per year is estimated to be $400,000, and operating costs per year is estimated to be $200,000.

The investment in the net working capital will be $40,000 at the beginning of the project; 40% of this will be recovered at the end of year 4, and the rest at the end of year 5. The tax rate is 30% and the CCA rate for depreciation purposes is 20%. The equipment can be sold at the end of the project for $60,000.

There is an on-going feasibility study regarding the project. The feasibility study is done by ACDT Consulting Group. They have been paid $50,000 a year ago, and they will be paid another $50,000 today. The cost of capital for the project is 10%. Calculate the NPV of the project to see if the company should undertake this project.

2. What is the simple payback period of a five-year project that costs $18,000 today and pays an annual after-tax cash flow of $4,000? Assume the cost of capital is 15%.

a. 4 years       

b. 4.5 years    

c. 3.5 years    

d. 5 years

3. What is the IRR of a project which requires an initial cash outlay of $12,345, and is expected to generate after-tax cash flows of $3,600 a year for three years and then $4,200 a year for two more? years?

a. 14.00%

b. 15.50%      

c. 16.20%      

d. 17.80%

4. Suppose you have an opportunity to invest in a project, which is expected to generate $5,000 in year 1, $7,000 in year 2, and $8,000 in year 3. The appropriate discount rate for the project is 10 percent. What is the initial investment of the project when the project's NPV is $4,000?

a. $17,609.25

b. $12,341.09

c. 21,500.00  

d. $20,218.50

Answer 1

1)

given cca rate = 20%

but in1st year we take only half rate i.e., 10%

cca rate is declining value method

above image shos formulas

above image shows formulas

calculation of after tax salvage value:

book value after year 5 = 600000 - (60,000 + 108000 +86400 + 69120 + 55296)

= 221184

amount paid to consulting group is sunk cost . so this need not be considered while taking decission.

sale value = 60,000

loss = 60,000 - 221184 = -161184

tax benefit on loss = 161184 * 0.3 = 48355.2

net salvage value = 60000 + 48355.2 = 108355.2

since NPV is positive project can be under taken.

2)

payback period is how fast a project recover its initial cash outflow

here initial cash outflow = 18000

yearlycash inflow = 4000

cumulative cash flow uptill year 4 = 4 x 4000 = 16000

so paybackperiod = 4 years + (18,000 - 16000) / 4000

= 4.5 years

3)

IRR = 16.20%

4)

NPV = present value of future cash flows - initial investment

4000 = 16,341.10 - initial invest ment

so initial investment = 16,341.10 - 4000 = 12,341.09 (0.01 difference is due to rounding error)