Question

Romagnoli Company is considering a 3-year investment project that involves the purchase of a new manufacturing equipment that costs $90,000 today. The equipment will be depreciated on a straight-line basis over 3 years at a rate of 33.33% per year. The company expects the salvage value of the equipment will equal zero at the end of year three. However, the company expects to sell the equipment at the end of third year to generate $10,000 after tax cash inflow. The utilization of the equipment will increase the company’s net operating working capital at the beginning of the project by $13,000 but this amount will be recovered at the end of the project.

The equipment is expected to generate revenues of $ 81,000 in the first year, and then revenues will grow by 1.5% per year after the first year. The operating costs (excluding depreciation) are expected to be $35,000 in the first year and then operating costs will grow by 1.5% per year after the first year. The company tax rate is 35% and its weighted average cost of capital (WACC) is 13.55 percent. The company’s beta coefficient is 1.21. What are the NPV and MIRR of this investment project?

Step 1

Since we have to handle multiple variables here, we will use Microsoft Excel to get the final answers:

- We will use the NPV function to get the NPV and
- MIRR function get MIRR
- Incremental sales & operating costs are growing year on year at 1.5%. Hence, the value of these variables in year 2 = value in year 1 x (1 + 1.5%)

Step 2

Please see the table on the white board. Please be guided by the second column titled “Linkage” to understand the mathematics. The last two rows highlighted in yellow cont...

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