Question

Two years ago the Krusty Krab Restaurant purchased a grill for $50,000. The owner, Eugene Krabs, has learned that a new grill is available that will cook Krabby Patties twice as fast as the existing grill. This new grill can be purchased for $100,000 and would be depreciated straight line over 8 years, after which it would have no salvage value. Eugene Krab expects that the new grill will produce EBITDA of $50,000 per year for the next eight years while the existing grill produces EBITDA of only $35,000 per year. The current grill is being depreciated straight line over its useful life of 10 years after which it will have no salvage value. All other operating expenses are identical for both grills. The existing grill can be sold to another restaurant now for $30,000. The Krusty Krab's tax rate is 30%.

If in the following tasks a number should be stated with negative sign, enter a minus sign "-" before the number. Don't use a comma as a thousand separator for the results.

a. The incremental free cash flow that the Krusty Krab will incur today (Year 0) if they elect to upgrade to the new grill is $. (round to the nearest dollar,)

b. The incremental free cash flow that the Krusty Krab will incur in year 1 if they elect to upgrade to the new grill is $. (round to the nearest dollar)

c. If the Krusty Krab's opportunity cost of capital is 6%, then the NPV for upgrading to the new grill is $. (round to the nearest dollar)

d. The IRR for upgrading to the new grill is %. (round to one decimal)

Answer 1

a)cost of new grill=80000
after tax cash flow from selling old grill=market value-((market-book)*tax))
market value=30000
depreciation per year=(cost-salvage)/years
=(50000-0)/10=5000
2 years over so new book value=50000-(2*5000)=40000
after tax cash flow=30000-((30000-40000)*30%)
=33000
cash flow at year 0=-80000+33000=-47000
b)incremental cash flow= (net icnome+depreication new)-(net income+depreciation old)
net income new=(EBITDA-depreciation)*(1-tax))
=(50000-(100000/8))*(1-30%)=26250
net income old:
=(35000-(50000/10))*(1-30%)=21000
incremental cash flow=(26250+(100000/8))-(21000+(50000/10))
=12750
c)use pv formule in excel
NPV=-47000+pv(6%,8,-12750,0,0)
=32174.87

d)The IRR is 21.36% and it can be found at the discount rate where the NPV is 0