Question

# A project requires an initial investment of \$950,000 depreciated straight-line to \$0 in 10 years. The...

A project requires an initial investment of \$950,000 depreciated straight-line to \$0 in 10 years. The investment is expected to generate annual sales of \$600,000 with annual costs of \$250,000 for 10 years. Assume a tax rate of 30% and the NPV of \$300,000. What is a discount rate of the project?

#### Homework Answers

Answer #1

Initial Investment = \$950,000
Salvage Value = \$0
Useful Life = 10 years

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = (\$950,000 - \$0) / 10
Annual Depreciation = \$95,000

Annual Sales = \$600,000
Annual Costs = \$250,000

Annual OCF = (Annual Sales - Annual Costs) * (1 - Tax Rate) + Tax Rate * Annual Depreciation
Annual OCF = (\$600,000 - \$250,000) * (1 - 0.30) + 0.30 * \$95,000
Annual OCF = \$350,000 * 0.70 + 0.30 * \$95,000
Annual OCF = \$273,500

Let Discount Rate be i%

Net Present Value = - Initial Investment + Annual OCF * PVA of \$1 (Discount Rate, Useful Life)
\$300,000 = -\$950,000 + \$273,500 * PVA of \$1 (i%, 10)
\$1,250,000 = \$273,500 * PVA of \$1 (i%, 10)
PVA of \$1 (i%, 10) = 4.57084

Using table values or financial calculator, i = 17.53%

Discount Rate = 17.53%

So, the discount rate of the project is 17.53% or 18%

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