Question

If your firm were to consider investing in the following project, calculate the NPV, IRR, and Payback values. Would this be a good investment for your company? PROJECT CASH FLOWS AND VALUES FOR A PROPOSED NEW PRODUCTION FACILITY: In year 0, invest $1,000,000 for a new production facility. The project will also require an investment of $50,000 into Net Working Capital. (Assume regular conditions of liquidation at project end.) The project is forecasted to last 4 years. Facility investment is depreciated straight-line to zero over the project life. Sales forecast per year is $400,000. Production costs per year is $150,000. Income tax rate is 41%. Forecasted salvage value for the production facility at year 4 is $200,000. Please show work. Cost of Capital is 12.842%

Answer 1

Time line		0	1	2	3	4
Cost of new machine		-1000000
Initial working capital		-50000
=Initial Investment outlay		-1050000
Sales			400000	400000	400000	400000
Profits	Sales-variable cost		250000	250000	250000	250000
-Depreciation	Cost of equipment/no. of years		-250000	-250000	-250000	-250000
=Pretax cash flows			0	0	0	0
-taxes	=(Pretax cash flows)*(1-tax)		0	0	0	0
+Depreciation			250000	250000	250000	250000
=after tax operating cash flow			250000	250000	250000	250000
reversal of working capital						50000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					118000
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						168000
Total Cash flow for the period		-1050000	250000	250000	250000	418000

Project
Year	Cash flow stream	Cumulative cash flow
0	-1050000	-1050000
1	250000	-800000
2	250000	-550000
3	250000	-300000
4	418000	118000

Payback period is the time by which undiscounted cashflow cover the intial investment outlay

this is happening between year 3 and 4

therefore by interpolation payback period = 3 + (0-(-300000))/(118000-(-300000))

3.72 Years

Project
Discount rate	12.842%
Year	0	1	2	3	4
Cash flow stream	-1050000	250000	250000	250000	418000
Discounting factor	1.000	1.128	1.273	1.437	1.621
Discounted cash flows project	-1050000.000	221548.714	196335.331	173991.360	257806.096
NPV = Sum of discounted cash flows
NPV Project =	-200318.50
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Reject project as NPV is negative

IRR is the rate at which NPV =0
IRR	4.04%
Year	0	1	2	3	4
Cash flow stream	-1050000.000	250000.000	250000.000	250000.000	418000.000
Discounting factor	1.000	1.040	1.082	1.126	1.172
Discounted cash flows project	-1050000.000	240291.733	230960.469	221991.566	356756.232
NPV = Sum of discounted cash flows
NPV Project =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	4.04%
Reject project as IRR is less than discount rate