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Company X is planning to add another project, which will generate $125,000 annual revenue for the...

Company X is planning to add another project, which will generate $125,000 annual revenue for the company in the next 6 years, with operating costs of $50,500 per year. To take this new project, the company has to purchase a new equipment with a price of $168,000 and add additional $40,000 in net working capital. The equipment will be depreciated using 7-year MACRS depreciation method (7-year MACRS depreciation rates are showing below). The company thinks the equipment could be sold out by the end of year 6 for $20,000. With a tax rate of 35% and required return of 18%, should the company take this project or not? Why? (Please show both NPV and IRR decisions). 7-year MACRS 1. 14.29% 2. 24.49% 3. 17.49% 4. 12.49% 5. 8.93% 6. 8.92% 7. 8.93% 8. 4.46%

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Expert Solution

NPV

Time line 0 1 2 3 4 5 6
Cost of new machine -168000
Initial working capital -40000
=Initial Investment outlay -208000
7 years MACR rate 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 13.39%
Sales 125000 125000 125000 125000 125000 125000
Profits Sales-variable cost 74500 74500 74500 74500 74500 74500
-Depreciation =Cost of machine*MACR% -24007.2 -41143.2 -29383.2 -20983.2 -15002.4 -14985.6 22495.2
=Pretax cash flows 50492.8 33356.8 45116.8 53516.8 59497.6 59514.4
-taxes =(Pretax cash flows)*(1-tax) 32820.32 21681.92 29325.92 34785.92 38673.44 38684.36
+Depreciation 24007.2 41143.2 29383.2 20983.2 15002.4 14985.6
=after tax operating cash flow 56827.52 62825.12 58709.12 55769.12 53675.84 53669.96
reversal of working capital 40000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 13000
+Tax shield on salvage book value =Salvage value * tax rate 7873.32
=Terminal year after tax cash flows 60873.32
Total Cash flow for the period -208000 56827.52 62825.12 58709.12 55769.12 53675.84 114543.28
Discount factor= (1+discount rate)^corresponding period 1 1.18 1.3924 1.643032 1.9387778 2.2877578 2.6995542
Discounted CF= Cashflow/discount factor -208000 48158.915 45120.023 35732.183 28765.092 23462.204 42430.444
NPV= Sum of discounted CF= 15668.86071

IRR

Total Cash flow for the period -208000 56827.52 62825.12 58709.12 55769.12 53675.84 114543.28
Discount factor= (1+discount rate)^corresponding period 1 1.2067588 1.45626687 1.7573629 2.1207132 2.5591894 3.0883244
Discounted CF= Cashflow/discount factor -208000 47091.033 43141.2134 33407.511 26297.342 20973.766 37089.135
NPV= Sum of discounted CF= 2.93876E-08
IRR is discount rate at which NPV = 0 = 20.68%

Accept project as NPV is positive and IRR is more than required rate

jeff jeffy answered 1 year ago
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