# Case95QuestionsPalmer1 Essay

2211 Words
Apr 9th, 2015
9 Pages

QUESTIONS

1. Table 1 contains the complete cash flow analysis 6 on GP Manufacturing’s basic information. Explain the inputs into 1) the net initial investment outlay at year 0, 2) the depreciation tax savings in each year of the project’s economic life, and 3) the project’s incremental cash flows?

1) $302,040 net initial investment includes:

($285,000) delivered cost

($18,000) installation cost

($2,500) removal cost

$4,000 current market value

($1,440) tax on proceeds

2) For year 1 the new system depreciated by 20 percent. Multiply that by the net initial investment and you get the total amount depreciated after 1 year, equal to $60,588. With a 36 percent tax rate you get the depreciated tax savings of $21,812.

Year 2- 32% depreciated

1. Table 1 contains the complete cash flow analysis 6 on GP Manufacturing’s basic information. Explain the inputs into 1) the net initial investment outlay at year 0, 2) the depreciation tax savings in each year of the project’s economic life, and 3) the project’s incremental cash flows?

1) $302,040 net initial investment includes:

($285,000) delivered cost

($18,000) installation cost

($2,500) removal cost

$4,000 current market value

($1,440) tax on proceeds

2) For year 1 the new system depreciated by 20 percent. Multiply that by the net initial investment and you get the total amount depreciated after 1 year, equal to $60,588. With a 36 percent tax rate you get the depreciated tax savings of $21,812.

Year 2- 32% depreciated

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Would this procedure be more appropriate for projects with very long or short lives?

Explain.

The payback’s reciprocal would be more useful for projects with very long lives. The payback reciprocal is best used when the useful life of an investment is twice the payback period. The IRR rises when the useful life of an investment increase which would then get closer to the higher reciprocal.

5. What is the project’s MIRR? What is the difference between the IRR and the MIRR? Which is better? Why?

MIRR = 13.03%

The difference between the MIRR and the IRR is that the IRR assumes that the cash flows are reinvested at the IRR, but the MIRR assumes the cash flows are reinvested at the firm’s cost of capital. The MIRR is better because it goes a step further and provides a clearer view of the future. The MIRR examines the reinvestment by determining what it does with the money it receives.

6. Suppose a potential customer wants to know the project’s profitability index (PI). What is the value of the PI for GP Manufacturing, and what is the rationale behind this measure?

The PI for GP MFG is:

The sum of the NPVs of future cash flows (cost savings) with tax savings from depreciation considered:

CF1 CF2 CF3 CF4 CF5 CF6 CF7 CF8

$48,640 48,640 48,640 48,640 48,640 48,640 48,640 48,640 $21,812 34,899 20,721 13,087 11,996 6,544 0 9,600

$70,452 83,539 69,361 61,727 60,636

Explain.

The payback’s reciprocal would be more useful for projects with very long lives. The payback reciprocal is best used when the useful life of an investment is twice the payback period. The IRR rises when the useful life of an investment increase which would then get closer to the higher reciprocal.

5. What is the project’s MIRR? What is the difference between the IRR and the MIRR? Which is better? Why?

MIRR = 13.03%

The difference between the MIRR and the IRR is that the IRR assumes that the cash flows are reinvested at the IRR, but the MIRR assumes the cash flows are reinvested at the firm’s cost of capital. The MIRR is better because it goes a step further and provides a clearer view of the future. The MIRR examines the reinvestment by determining what it does with the money it receives.

6. Suppose a potential customer wants to know the project’s profitability index (PI). What is the value of the PI for GP Manufacturing, and what is the rationale behind this measure?

The PI for GP MFG is:

The sum of the NPVs of future cash flows (cost savings) with tax savings from depreciation considered:

CF1 CF2 CF3 CF4 CF5 CF6 CF7 CF8

$48,640 48,640 48,640 48,640 48,640 48,640 48,640 48,640 $21,812 34,899 20,721 13,087 11,996 6,544 0 9,600

$70,452 83,539 69,361 61,727 60,636

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