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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?

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?

check_circleAnswer
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...

A
C
D
Linkage
249 Year, n
1
2
3
A
(90,000)
250 Initial investment
251 Depreciation schedule
33.33%
33.33%
33.33%
252
253 Incremental Revenue
81,000
82,215
83,448
254 y-o-y growth rate
255 Incremental costs
256 y-o-y growth rate
257 Depreciation
1.50%
1.50%
(35,000)
(35,525)
(36,058)
C
1.50%
1.50%
(30,000)
(30,000)
(30,000)
D dxA
E B+C+D
F = Ex (1-35%)
G F-D
258 EBIT
16,000
16,690
17,390
259 NOPAT
10,400
10,849
11,304
260 OCF
40,400
40,849
41,304
261
262 Investment in working capital H
After tax proceeds from sale
263 of the equipment
(13,000)
13,000
10,000
264
265 Net cash flows
266 Discount rate
267 NPV
(103,000)
JA+G+H+
40,400
40,849
64,304
13.55%
R
8,181.51 ENPV(C266,D265:F265)+C265
16.48% MIRR(C265:F265,C266,C266)
268 MIRR
Cm
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A C D Linkage 249 Year, n 1 2 3 A (90,000) 250 Initial investment 251 Depreciation schedule 33.33% 33.33% 33.33% 252 253 Incremental Revenue 81,000 82,215 83,448 254 y-o-y growth rate 255 Incremental costs 256 y-o-y growth rate 257 Depreciation 1.50% 1.50% (35,000) (35,525) (36,058) C 1.50% 1.50% (30,000) (30,000) (30,000) D dxA E B+C+D F = Ex (1-35%) G F-D 258 EBIT 16,000 16,690 17,390 259 NOPAT 10,400 10,849 11,304 260 OCF 40,400 40,849 41,304 261 262 Investment in working capital H After tax proceeds from sale 263 of the equipment (13,000) 13,000 10,000 264 265 Net cash flows 266 Discount rate 267 NPV (103,000) JA+G+H+ 40,400 40,849 64,304 13.55% R 8,181.51 ENPV(C266,D265:F265)+C265 16.48% MIRR(C265:F265,C266,C266) 268 MIRR Cm

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