(10-8) NPVs, IRRs, and MIRRs for Independent Projects
Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year’s capital budget. The projects are independent. The cash outlay for the truck is $17,100 and that for the pulley system is $22,430. The firm’s cost of capital is 14%. After-tax cash flows, including depreciation, are as follows:
Year Truck Pulley
1 $5,100 $7,500
2 $5,100 $7,500
3 $5,100 $7,500
4 $5,100 $7,500
5 $5,100 $7,500
Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept-reject decision for each. Year Truck Pulley
0 -$17,200 -$22,430
1 $5,100 $7,500
2 $5,100 $7,500
3 $5,100 $7,500
4 $5,100
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If company fails to adjust expected inflection on their cost of capital then the cost of capital which the company is using to discount expected cash flows will be lower than the inflection adjusted cost of capital. As company is using lower cost of capital rate to discount their cash flows, the discounted cash flow will be higher and calculated NPV will be lower.
Problem 11- 7
"New-Project Analysis"
You have been asked by the president of your company to evaluate the proposed acquisition of a new spectrometer for the firm’s R&D department. The equipment’s basic price is $70,000, and it would cost another $15,000 to modify it for special use by your firm. The spectrometer, which falls into the MACRS 3-year class, would be sold after 3 years for $30,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,000. The spectrometer would have no effect on revenues, but it is expected to save the firm $25,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40%.
a. What is the net cost of the spectrometer? (That is, what is the Year-0 net cash flow?)
b. What are the net operating cash flows in Years 1, 2, and 3? (26220,30300,20100)
c. What is the additional (nonoperating) cash flow in Year 3? 24380
d. If the project’s cost of capital is 10%, should the spectrometer be
b.What are the amounts and timing of the acquisition investment’s free cash flow from 2013 through 2022?
2. Use the projections provided in the case to compute the incremental cash flows for the PCB project. Provide a reasonable estimate for cash flows after 2009 as well.
4. Did the cash flow from operations cover both the capital expenditures and the firm’s dividend payments, if any?
Futronics Inc. is a $2 billion firm that sells communications services. Founded in 1937, Futronics Inc. has provided consumer products, as well as government systems and services, for well over half a century. Due to a sharp increase in competition, flattened sales, and external economic conditions, Futronics Inc. is implementing a corporate overhead reduction program. The proposal is to replace the company’s central office stores with outside vendors. The investment will cost $1,000,000 and yield incremental cash flows of $450,000 in year one (1), $350,000 in year two (2), $300,000 in year three (3), and $250,000 in year four (4). There is no salvage value of the asset, and the firm has a cost of capital of 8%. Using capital budget methods, Net Profit Value, Internal Rate of Return and Payback method, the capital investment can be appraised. Futronics Inc.
1. The first step to evaluating the cash flows is to conduct the depreciation tax flow analysis. Depreciation is not a cash flow, but the depreciation expense lows the taxes payable for the company. As a result, the tax effect of deprecation needs to be calculated as a cash flow. There are two depreciable items on the company's balance sheet the building and the equipment. The equipment is known to have a seven year depreciable life, which will be assumed to be straight line. The building is also assumed to be subject to straight line depreciation, this time of forty years. The tax saving reflects the depreciation expense multiplied by the tax rate, which in this case is assumed to be 28%. The following table illustrates the tax effect in future dollars of the depreciation expense:
Operating cash flow was not enough to cover capital investments (this firm does not to appear to pay dividends as it does not show in the prior 3 years). The firm is financing it operations from the issuance of common stock. $23,082 was raised during the period, which is covering its investments in capital expenditures.
5. What is the project’s MIRR? What is the difference between the IRR and the MIRR? Which is
Warren Company makes candy. During the most recent accounting period, Warren paid $3,000 for raw materials, $4,000 for labor, and $2,000 for overhead costs that were incurred to make candy. Warren started and completed 10,000 units of candy, of which 7,000 were sold. Based on this information, Warren would recognize which of the following amounts of expense on the income
year 1 net income would do). Then, its year 2 opening net assets are $276.36,
Any type of project should be accepted if the NPV is positive and rejected if it is negative.
Currently, Starbucks is considering making an investment in a new manufacturing plant in Augusta, GA. The capital budgeting project requires an initial investment outlay of $ 40 million and is expected to general annual cash flows of 5.200.000, 6.500.000, 8.200.000, 8.700.000, 9.000.000, 9.550.000, and 11.500.000 for years 1 to 7, respectively. Starbucks estimates that the project has a below-average risk and sets the discount rate at 8.06 % -- based on the company’s Weighted Average Cost Of Capital (WACC). The discount rate is effectively the desired return on an investment an
A few months have now passed and AirJet Best Parts, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows:
class he had missed had been devoted to a lecture and discussion of the statement of cash flows, and
a. the term of the lease exceeds 75% of the asset’s useful life; or b. the present value of the lease exceeds 90% of the asset’s fair value a. is not the case: useful life is 20 years, term of lease is 10 years b. PV of the 10 payments of $ 1 mio at the end of the year with 10% rate is: $ 6.144 mio (see table PV). That is 95% of the value of the asset of $ 6.5 mio
2. At the end of its first year of operations, Matlocke Company has total assets of $2,000,000 and total liabilities of $1,200,000. The owner originally invested $200,000 in the business, but has not made any further investments or taken any withdrawals. What is the first year 's net income for Matlocke Company?