Case95QuestionsPalmer1 Essay

Estimate the project’s operating cash flows for each year of the project’s economic life. (Hint: Use Table 2 as a guide)

What are the amounts and timing of the follow-up expansion investment opportunity’s free cash flow from 2013 through 2022?

When choosing between projects with acceptable IRRs, the one with the highest IRR should be chosen.

Depreciation Schedule Year 0 1 2 3 4 5 6 7 8 9 10 Building 10000 10000 10000 10000 10000 10000 10000 10000 10000 10000 Equip 142857.1429 142857.1 142857.1 142857.1 142857.1 142857.1 142857.1 0 0 0 Dep Exp 152857.1429 152857.1 152857.1 152857.1 152857.1 152857.1 152857.1 10000 10000 10000 Tax Credit 42800 42800 42800 42800 42800 42800 42800 2800 2800 2800

The ranking of projects differs, depending on the use of IRR or NPV measures. Which project should be selected? Why is the IRR ranking misleading?

A project has initial costs of $3,000 and subsequent cash inflows in years 1 – 4 of

According to the depreciation rates used by the company and described in the Production Cost Report, if a company adds 50 new workstations at a cost of $250,000 each and also spends $5 million for an addition to its assembly plant to accommodate the new workstations, then its annual depreciation costs will rise by

       One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.

i. In 1985 the cash inflow caused by the tax shelter from depreciation will be calculated using the existing 46% rate. In 1986 that tax rate will be reduced to 34% and the equipment will be sold that year so cash inflows from the old equipment will terminate that same year.

Suppose a potential customer wants to know the projects for profitability index (PI). What is the value of the PIU of Lone Star, and what is the rationale behind this measure? Profitability Index = PI Present Value of Future Cash Flow over Initial Cost = 212500 + 36944 = 249,455 over Initial Cost 212,500 equal 1.173 for every $1 invested in the project, the total value created is 1.173. Therefore the Chicago Valve Company has a net profit of 1.173 – 1=$0.173 per every dollar invested.

As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first ("Internal Rate Of Return - Irr", 2014).” When looking at both companies discount rates, they are within 1% of one another. The higher the discount rates the better the profit for that particular company. Corporation A has a discount rate of 10%, while Corporation B has a discount rate of 11%. Generally speaking, the higher the discount rate the more profitable that company will become.

NPV profile – Illustrates the relationship between a typical project’s NPV and its IRR in context of the firm’s discount rate.

Let us assume we set up an investment that requires an initial investment of $100,000 and we expect to receive benefits and incur costs as $40,000 35,000 -20,000 40,000 38,000

|  |Year 0 |Year 1 |Year 2 |Year 3 |Year 4 |Year5 | | |OCF | |$750,000 |$4,218,800 |$7,335,300 |$9,102,100 |$10,160,300 | | |Capital spending |–$50,000,000 |–25,000,000 | | | | | | |Net working capital | |–1,200,000 |–960,000 |–640,000 |–400,000 |–160,000 | | |Terminal value | | | | | |148,575,886 | | |Total cash flows |–$50,000,000 |–$25,450,000 |$3,258,800 |$6,695,300 |$8,702,100 |$158,576,186 | |

Often times, during the life of a project, cash flows must be reinvested to cover depreciation. This will give a negative cash flow for that period, thus leading to more than one IRR. If there is more than one IRR, than calculating only 1 IRR for the project is not reliable. NPV must be used for this type of project.