Miami Machine Shops, Ltd. is consideringpurchasing a vertical drill machine. The machinewill cost $62,000 and will have an eight-year servicelife. The selling price of the machine at the end ofeight years is expected to be $5,000 in today’s dollars. The machine will generate annual revenues of$22,000 (today’s dollars), but the company expectsto have an annual expense (excluding depreciation)of $9,500 (today’s dollars). The asset is classified asa seven-year MACRS property. The project requiresa working-capital investment of $10,000 at year 0.The marginal income tax rate for the firm is averaging 35%. The firm’s market interest rate is 18%.(a) Determine the internal rate of return of thisinvestment.(b) Assume that the firm expects a general inflationrate of 5%, but that it also expects an 8% annualincrease in revenue and working capital and a6% annual increase in expense caused by inflation. Compute the real (inflation-free) internalrate of return. Is this project acceptable?
Miami Machine Shops, Ltd. is considering
purchasing a vertical drill machine. The machine
will cost $62,000 and will have an eight-year service
life. The selling price of the machine at the end of
eight years is expected to be $5,000 in today’s dollars. The machine will generate annual revenues of
$22,000 (today’s dollars), but the company expects
to have an annual expense (excluding
of $9,500 (today’s dollars). The asset is classified as
a seven-year MACRS property. The project requires
a working-capital investment of $10,000 at year 0.
The marginal income tax rate for the firm is averaging 35%. The firm’s market interest rate is 18%.
(a) Determine the
investment.
(b) Assume that the firm expects a general inflation
rate of 5%, but that it also expects an 8% annual
increase in revenue and
6% annual increase in expense caused by inflation. Compute the real (inflation-free) internal
rate of return. Is this project acceptable?
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