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The table below offers EBIT for a potential capital investment for Fake Company Alpha. You should...

The table below offers EBIT for a potential capital investment for Fake Company Alpha. You should be able to determine a few things once you consider the following:

  • The initial investment is $12,000.
  • Depreciation is straight line over four years.
  • The company's WACC is estimated at 8.5%.
  • Company analysts estimate that a proper salvage value at the end of the project life of four years is 30% of the initial investment.
  • The company's tax rate is 27.0%.
YEAR 1 YEAR 2 YEAR 3 YEAR 4
EBIT $(3,600) $(2,725) $1,875 $5,000

What is this project's internal rate of return?

Solutions

Expert Solution

Time line 0 1 2 3 4
Cost of new machine -12000
=Initial Investment outlay -12000
EBIT= -3600 -2725 1875 5000
-taxes =(Pretax cash flows)*(1-tax) -2628 -1989.25 1368.75 3650
+Depreciation 3000 3000 3000 3000
=after tax operating cash flow 372 1010.75 4368.75 6650
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 2628
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 2628
Total Cash flow for the period -12000 372 1010.75 4368.75 9278
Discount factor= (1+discount rate)^corresponding period 1 1.066766 1.13799 1.2139692 1.2950212
Discounted CF= Cashflow/discount factor -12000 348.7175 888.1888 3598.7322 7164.3613
NPV= Sum of discounted CF= -0.000187444
IRR is discount rate at which NPV = 0 = 6.68%

jeff jeffy answered 1 year ago
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