Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)

12th Edition

ISBN: 9781259144387

Author: Richard A Brealey, Stewart C Myers, Franklin Allen

Publisher: McGraw-Hill Education

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Textbook Question

Chapter 6, Problem 16PS

Project NPV and IRR A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,000 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 21% and can claim 100% bonus depreciation on the investment. Suppose the opportunity cost of capital is 8%. Ignore inflation.

a. Calculate project NPV for each company.
b. What is the IRR of the after-tax cash flows for each company? Why are the IRRs for A and B the same?

Expert Solution & Answer

Chapter 6 Solutions

Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)

Ch. 6 - Cash flows Which of the following should be...Ch. 6 - Real and nominal flows Mr. Art Deco will be paid...Ch. 6 - Cash flows True or false? a. A projects...Ch. 6 - Depreciation How does the PV of depreciation tax...Ch. 6 - Working capital The following table tracks the...Ch. 6 - Prob. 6PS Ch. 6 - Prob. 7PS Ch. 6 - Mutually exclusive investments and project lives...Ch. 6 - Replacement decisions Machine C was purchased five...Ch. 6 - Prob. 10PS

Ch. 6 - Prob. 12PS Ch. 6 - Working capital Each of the following statements...Ch. 6 - Depreciation Ms. T. Potts, the treasurer of Ideal...Ch. 6 - Project NPV and IRR A project requires an initial...Ch. 6 - Project NPV A widget manufacturer currently...Ch. 6 - Project NPV Marsha Jones has bought a used...Ch. 6 - Project NPV United Pigpen is considering a...Ch. 6 - Project NPV Hindustan Motors has been producing...Ch. 6 - Equivalent annual cash flows As a result of...Ch. 6 - Prob. 25PS Ch. 6 - Replacement decisions Hayden Inc. has a number of...Ch. 6 - Prob. 27PS Ch. 6 - Prob. 28PS Ch. 6 - Prob. 29PS Ch. 6 - Prob. 30PS Ch. 6 - The cost of excess capacity The presidents...Ch. 6 - Effective tax rates One measure of the effective...Ch. 6 - Equivalent annual costs We warned that equivalent...

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Inflation Adjustments The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has a cost of $150,000. The project will produce 1,000 cases of mineral water per year indefinitely. The current sales price is $138 per case, and the current cost per case is $105. The firm is taxed at a rate of 34%. Both prices and costs are expected to rise at a rate of 6% per year. The firm uses only equity, and it has a cost of capital of 15%. Assume that cash flows consist only of after-tax profits, because the spring has an indefinite life and will not be depreciated. Should the firm accept the project? (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.) Suppose that total costs consisted of a fixed cost of $10,000 per year plus variable costs of $95 per unit, and only the variable costs were expected to increase with inflation. Would this make the project better or worse? Continue to assume that the sales price will rise with inflation.
Redbird Company is considering a project with an initial investment of $265,000 in new equipment that will yield annual net cash flows of $45,800 each year over its seven-year life. The companys minimum required rate of return is 8%. What is the internal rate of return? Should Redbird accept the project based on IRR?

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