Question

Kids Moving (KM), a small not-for-profit sports center is considering purchasing a new set of pitching machines they currently rent. There will be annual maintenance on the machines that KM will now have to pay. And at the end of 5 years, the machine will be worthless and you will have to pay to have it taken away. The following data has been obtained:

Cost of equipment needed $444,444

Working capital needed (released at end of project) $20,000

Annual savings on rent not paid $180,000

Annual maintenance expense $66,666

Disposal cost at the end of the project * $8,888

cost of capital 7%

* You will have to pay $8,888 to have the machine taken away.

Complete the following questions and submit as a Microsoft EXCEL document.

Compute the NPV and the IRR of the investment.

Should the KM invest in the project?

What would your answer be if the purchase will require additional staff training all during year 1 of $11,000? (Net Present Value? IRR? Decision?)

Steps

Put in the year - Don’t forget to start with time 0 (now).

Put in the interest rate (not the tax rate– remember this is a percentage).

Skip a line.

Put in the cash inflows and outflows.

Reference the taxes if applicable.

Compute the cash flows and highlight.

Compute the PV of the cash flows (see above).

Compute the net present value by summing the PV of the cash flows from step G (do not use the NPV key).

Compute the internal rate return of the cash flows (highlighted amount).

Evaluate – consider mission, strategy and risk, ethical implications for all stakeholders.

Answer 1

Answer:

KM will now have to pay. At the end of 5 years, the machine will be worthless & you will have to pay to have it taken away.

Initial outlay = 444444+20000

working capital = $464444
Cash inflows = rent did not paid = $180000
Cash outflows = maintainence expenses = $66666.
Cash inflows for the 5th year = rent did not paid + working capital released

= 180000+20000 = $200000.
Cash outflows for the 5th year = maintainence cost + cost of disposing the machine = 66666+8888 = $75554
Cost of capital = 7%

Formula for IRR =
where, R1 is lower discount rate = 7%
R2 = higher discount rate = 8%
NPV1= higher npv value derived by R1 = 8,170
NPV2 = lower discount value derived by R2 =(4,384)
Hence, after substituting the above figures in the formula for IRR,
we get IRR as 7.6508%.
IRR is the rate at which the project breaks even, i.e. the NPV of the project is 0.
ANSWERS :
1. NPV OF THE PROJECT IS $8,170 and IRR is 7.6508%
2. Since the NPV of the project is positive and IRR is higher than the cost of capital, the project in question is feasible. i.e. KM should purchase the pitching machine.
3. When the additional cost of $11,000 is incurred in the first year, the new NPV is negative as calculate below. In such a case IRR is 6.8375%, which is lower than the cost of capital. And hence, in such a scenario, investing in the pitching machine will not be profitable. KM should not purchase the machine.