Evaluate the following capital budgeting project by a profitable food products firm. The company is considering investment in specialized equipment for a cost of $900 million including installation and modification expenses. The equipment is categorized as a ten-year asset to be depreciated to a zero-salvage value. The firm can depreciate 10% of the investment in year one and 18% in year two when the equipment will be sold, net of expenses, to another organization for $600 million. The investment is projected to generate $100 million in pre-tax, net operating income for year one and $150 million in year two. The firm pays income taxes and capital gains taxes at the 20% marginal rate. The firm is profitable and would offset taxes (or recapture prior taxes paid) in any year the project is unprofitable. The firm’s weighted, average after-tax cost of capital is 5.00%. First, develop the annual after-tax, pre-leverage operating and non-operating cash flow for the investment for year zero, year one and year two. Clearly label all cash flows. Second, either derive he NPV or the IRR for the project and indicate whether and why the project is acceptable or unacceptable.

NPV is the net current worth of cash flows that are expected to occur in the future.

Answered: Evaluate the following capital…

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter13: Capital Budgeting: Estimating Cash Flows And Analyzing Risk

Section: Chapter Questions

Problem 1MC

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Evaluate the following capital budgeting project by a profitable food products firm. The company is considering investment in specialized equipment for a cost of $900 million including installation and modification expenses. The equipment is categorized as a ten-year asset to be depreciated to a zero-salvage value. The firm can depreciate 10% of the investment in year one and 18% in year two when the equipment will be sold, net of expenses, to another organization for $600 million. The investment is projected to generate $100 million in pre-tax, net operating income for year one and $150 million in year two. The firm pays income taxes and capital gains taxes at the 20% marginal rate. The firm is profitable and would offset taxes (or recapture prior taxes paid) in any year the project is unprofitable. The firm’s weighted, average after-tax cost of capital is 5.00%. First, develop the annual after-tax, pre-leverage operating and non-operating cash flow for the investment for year zero, year one and year two. Clearly label all cash flows. Second, either derive he NPV or the IRR for the project and indicate whether and why the project is acceptable or unacceptable.

Definition Definition Tax imposed by the government on the "gain" or increase in the value of an asset at the time of its sale by the owner. Capital gain is computed based on the purchase price and sale price of the asset. If the sale price of the asset is more than the purchase price, there is a gain on the sale of asset. A tax is imposed on such gain in accordance with the applicable tax rates at the time of sale.

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