The Boston Culinary Institute is evaluating a classroom remodeling project. The

Question

The Boston Culinary Institute is evaluating a classroom remodeling project. The cost of the remodel will be $300,000 and will be depreciated over 5 years using the straight-line method. The remodeled room will accomodate 5 extra students per year. Each student pays annual tuition of $22,000. The before-tax incremental cost of a student (e.g., the cost of food prepared and consumed by a student) is $2,000 per year. The company's tax rate is 40% and the company requires a 12% rate of return on the remodeling project.

Required:

Assuming a 5-year time horizon, what is the internal rate of return of the remodeling project? Should the company invest in the remodel?

          Cash flow per year:

          Revenue- - - - - - - - - - - - - - - - - - - - - - - - - -  [formula]

          Less costs other than depreciation- - - - - - - - [formula]

          Depreciation- - - - - - - - - - - - - - - - - - - - - - - - [formula]

          Title- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - [formula]

          Title- - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  [formula]

          Net income- - - - - - - - - - - - - - - - - - - - - - - - - [formula]

          Title- - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  [formula]

          Cash flow- - - - - - - - - - - - - - - - - - - - - - - - - -  [formula]

                   

                Annuity factor equals cost divided by annual cash flow: [formula]

For Excel to determine the internal interest rate you must provide a matrix of cash flows as follows:

          Cash out: [amount]

          Cash in year 1: [amount]

          Cash in year 2: [amount]

          Cash in year 3: [amount]

          Cash in year 4: [amount]

          Cash in year 5: [amount]

Excel internal rate of return (IRR) formula: [formula]

          

Explanation / Answer

Hi,

Please find the answer as follows:

Internal Rate of Return using above mentioned figures = 12.38% or 12%

The company can accept the project as the IRR is almost equal to the required rate of return.

Thanks.

Revenue 110000 Less Costs other than Depreciation 10000 Less Depreciation (300000/5) 60000 Earnings Before Taxes 40000 Less Tax 16000 Net Income 24000 Add Depreciation 60000 Cash Flow 84000

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