Textbook solution for this problem was incorrect apparently though I don\'t know
ID: 2580593 • Letter: T
Question
Textbook solution for this problem was incorrect apparently though I don't know why. Hoping for some explanation here
10.50 K&G; Chemical Company has just received a special subcontracting job from one of its clients. This two-year project requires the purchase of a special-purpose painting sprayer for $60,000. This equipment falls into the MACRS five-year class. After the subcontracting work is completed at the end of two years, the painting sprayer will be sold for $40,000 (actual dollars). The painting system will require an increase in the company's net working capital (for spare-parts inventory, such as spray nozzles) of $5,000. This investment in working capital will be fully recovered at the project termination. The project will bring in an additional annual revenue of $120,000 (today's dollars), but it is expected to incur an additional annual operating cost of $60,000 (today's dollars). It is projected that because of inflation, there will be sales-price increases at an annual rate of 5%, which implies that annual revenues will also increase at an annual rate of 5%. An annual increase of 4% for expenses and working-capital requirements is expected. The company has a marginal tax rate of 30%, and it uses a market interest rate of 15% for project evaluation during the inflationary period. The firm expects a general inflation of 8% during the project period a. Compute the after-tax cash flows in actual dollars b. What is the rate of return on this investment (real earnings)?Explanation / Answer
Year 0 1 2 Cost of sprayer -60000 NWC introduced -5000 -200 -208 NWC recovered 5408 After-tax salvage 36640 Total CAPEX & NWC ----1 -65000 -200 41840 Operating cash flows Revenues 126000 132300 Less: Expenses -62400 -64896 Less: Depn. -12000 -19200 EBIT 51600 48204 Tax at 30% -15480 -14461 EAT 36120 33743 Add Back depn. 12000 19200 Operating cash flow------2 48120 52943 a.Net annual after-tax cash flows------1+2 -65000 47920 94783 Real Discount rate= (1+Nominal Rate)/(1+Inflation)-1 ie. (1.15/1.08)-1= 6.48% Real value cash flows -65000 47920/1.08= 94783/1.08^2= -65000 44370.37 81261.15 PV at 6.48% 1 0.93914 0.88199 PV at 6.48% -65000 41670.14 71671.56 NPV 48342 Real rate of return= NPV/Initai investment 48342/60000= 80.57% Taking into account depn.tax-shields lost (48342-4937)/60000= 72.34% WORKINGS: Original cost 60000 Less: Acc. Depn.(60000*52%) -31200 Carrying value 28800 Sale proceeds 40000 Gain on sale (40000-28800) 11200 Tax on gain(11200*30%) 3360 After-tax sale proceeds(40000-3360) 36640 Year MACRS Rates Depn. Amt. Tax shield lost Real value tax shield lost PV F at 6.48% PV of tax shieldlost 1 2 3=60000*(Col.2)% 4=3*30% 5=4/(1+0.08)^n 6=5/PVF 7=5*6 1 20 2 32 3 19.2 11520 3456 2743.48 0.82832 2272 4 11.52 6912 2073.6 1524.16 0.77791 1186 5 11.52 6912 2073.6 1411.26 0.73057 1031 6 5.76 3456 1036.8 653.36 0.68611 448 100 4937
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.