Question

a) Boulder Milling is evaluating a proposal to invest in a new piece of equipment costing $160,000 (salvage value = $10,000) with the following annual cash flows over the equipment's 4-year useful life. There is an initial working capital payment of $50,000 required for this equipment.

Cash revenues
Cash expenses
Depreciation expenses (straight-line) Income provided from equipment Cost of capital
Note: Depreciation is a non-cash expense

$120,000 (64,000) (20,000)

$36,000 12 percent

Periods	Present value of $1
	8%	10%	12%
Year 1	0.926	0.909	0.893
Year 2	0.857	0.826	0.797
Year 3	0.794	0.751	0.712
Year 4	0.735	0.683	0.636

a) (Show work) Calculate the present value, net present value and internal rate of return of the investment (Points 10.0)? Using the answer from a), is your recommendation to proceed with the project? Why or why not. (Points 2.5)?

b) if prices rise and Boulder’s initial investment increases to $175,000, calculate the net present value and internal rate of return. Should they proceed with the investment? Why or why not

Answer 1

Annual Net Cash Inflow = $120000 - $64000 = $56000
Net Investment = $160000 + $50000 = $210000

a.

Year	Annual Cash Flows	PV Factor @12%	PV
0	$                     -210,000	1	$           -210,000
1	$                         56,000	0.893	$               50,008
2	$                         56,000	0.797	$               44,632
3	$                         56,000	0.712	$               39,872
4	$                       116,000	0.636	$               73,776
		NPV	$                -1,712

Cash Flow for Year 4 = $56000 + $50000 (Working Capital Recovered) + $10000 (Salvage Value)

For IRR, NPV is 0,
Since NPV at 12% is negative, lets try another rate of 11%

Year	Annual Cash Flows	PV Factor @11%	PV
0	$                     -210,000	1	$           -210,000
1	$                         56,000	0.901	$               50,456
2	$                         56,000	0.812	$               45,472
3	$                         56,000	0.732	$               40,992
4	$                       116,000	0.659	$               76,444
		NPV	$                 3,364

IRR = 11% + $3364 / ($3364 + 1712) = 11.64%

Company should not proceed with project, as NPV at cost of capital is negative and IRR is lower than Cost of Capital

b.

Year	Annual Cash Flows	PV Factor @12%	PV
0	$                     -225,000	1	$           -225,000
1	$                         56,000	0.893	$               50,008
2	$                         56,000	0.797	$               44,632
3	$                         56,000	0.712	$               39,872
4	$                       116,000	0.636	$               73,776
		NPV	$             -16,712

Year	Annual Cash Flows
0	$                     -225,000
1	$                         56,000
2	$                         56,000
3	$                         56,000
4	$                       116,000
IRR	8.81%

Excel Formula
IRR =IRR(C507:C511,0.1)

Company should not proceed with project, as NPV at cost of capital is negative and IRR is lower than Cost of Capital