XYZ Corporation is considering an expansion project. To date they have spent $65

Question

XYZ Corporation is considering an expansion project. To date they have spent $65,000 investigating the viability of the project and have decided to proceed. The CEO of XYZ spent $20,000 last year on his business trip to New York where he discussed about the proposed new project with the board members. The company spent $50,000 on a marketing study before its current analysis regarding whether to accept or reject the project. The proposed project will cost $550,000. The project will be depreciated over a 3 year MACRS class life. XYX would use the 3-year MACRS method to depreciate the machine and equipment which are 33% 45%, 15% and 7%.
If the project is undertaken the company will need to increase its inventories by $45,000, and its accounts payable will rise by $10,000. The company will realize an additional $750,000 in sales over each of the next four years. The company

Explanation / Answer

Initial investment = 550,000 + 45,000 - 10,000 = 585,000

Year 1 cashflow = (750,000-540,000)*(1-35%) + 550,000*33%*35% = 200,025

Year 2 cashflow = (750,000-540,000)*(1-35%)*1.045 + 550,000*45%*35% = 229,267.5

Year 3 cashflow = (750,000-540,000)*(1-35%)*1.045^2 + 550,000*15%*35% + 55,000-35%*(55,000-550,000 * 7%) + 45,000-10,000 = 253,469.18

NPV = -585,000 + 200,025/1.105 + 229,267.5/1.105^2 + 253,469.18/1.105^3 = -28,353.74

IRR can be calculated in Excel as 7.82%

As NPV is less than zero, we should NOT accept the project.

Hope this helped ! Let me know in case of any queries.

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