Chapter 11, Problem 1OR

a)

Summary Introduction

Case summary:

Company DCD is the largest distributor of graphic novels and comics in the world. In the year 2013, Company DCD came up with a new plan to help the comic book stores to expand.

The cost of opening a new store has to make a lot of investment to fill the shelves with the inventory of the merchandise. The company must look at the inflows and outflows to make the relevant decisions.

To calculate: The net present value and the internal rate of return.

Introduction:

Net present value (NPV):

It is the difference between the present value of cash inflows and cash outflows within a period of time.

Internal rate of return:

It is a method to calculate the profitability of the potential investments. It is a discount rate which makes the net present value as zero.

Explanation of Solution

Given information:

Investment = $400,000

Cashflow = $62,000

Tax rate = 35%

Calculation of after-tax annual cash flow:

$\begin{array}{c}\text{After tax annual cash flow}=\text{Cashflow}\times \left(\text{1}-\text{Tax rate}\right)\\ =62,000\times \left(1-\frac{35}{100}\right)\\ =\$40,300\end{array}$

After-tax cash flow in terminal year:

$\begin{array}{c}\text{After-tax cash flow}=40,300+250,000\\ =\$290,300\end{array}$

Calculation of NPV and IRR:

Formula:

b)

Summary Introduction

To calculate: The net present value and the internal rate of return.

Introduction:

Net present value (NPV):

It is the difference between the present value of cash inflows and cash outflows within a period of time.

Internal rate of return:

It is a method to calculate the profitability of the potential investments. It is a discount rate which makes the net present value as zero.

Explanation of Solution

Given information:

Investment = $300,000

Cashflow = $62,000

Tax rate = 35%

Calculation of after-tax annual cash flow:

$\begin{array}{c}\text{After tax annual cash flow}=\text{Cashflow}\times \left(\text{1}-\text{Tax rate}\right)\\ =62,000\times \left(1-\frac{35}{100}\right)\\ =\$40,300\end{array}$

After-tax cash flow in terminal year:

$\begin{array}{c}\text{After-tax cash flow}=40,300+150,000\\ =\$190,300\end{array}$

Calculation of NPV and IRR:

Formula: