Question

Cash Flow Estimation:
Example 1:
You are considering expanding your product line. You feel you can sell 100,000 of these products per year for 4 years (after which time this project is expected to shut down). The product will sell for $6 each, with variable costs of $3 for each one produced, while annual fixed costs associated with production will be $90,000. In addition, there will be a $200,000 initial expenditure associated with the purchase of new production equipment. It assumed that this initial expenditure will be depreciated using the simplified straight-line method down to zero over 4 years .This project will also require a one-time initial investment of $30,000 in net working capital associated with inventory. Finally, assume that the firm’s marginal tax rate is 34 percent.

Example 2:
Firm ABC is considering to invest in a project to reduce costs by $70,000 annually. The equipment costs $200,000, had a 4-year life (will be depreciated as a 3-year MACRS asset), requires no additional investment in net working capital, and has a salvage value of $50,000. The firm’s tax rate is 39% and the required return on investments in this risk class is 10%. What is the NPV and IRR of this project? (The MACRS’s first three years’ depreciation rates in order are: 33.33%, 44.44% and 14.82%.)

Please provide all work for these problems, not just final solution so they can be modeled for similar problems, thank you :)

Answer 1

ABC	0	1	2	3	4
MACRS %		33.33%	44.44%	14.82%	7.41%
Investment	-200,000
Salvage					50,000
Savings		70,000	70,000	70,000	70,000
Depreciation		-66,660	-88,880	-29,640	-14,820
EBT		3,340	-18,880	40,360	55,180
Tax (39%)		-1,303	7,363	-15,740	-21,520
Profits		2,037	-11,517	24,620	33,660
Cash Flows	-200,000	68,697	77,363	54,260	78,980
IRR	14.77%
NPV	$21,099.02

Depreciation = MACRS % x Investment

Cash Flows = Investment + Profits + Depreciation + Salvage x (1 - tax)

IRR and NPV can be calculated in excel or calculator

IRR = IRR(-200000....78980) = 14.77%

NPV = NPV(10%, 68697...78980) - 200000 = $21,099.02

For the first example, there is no question.