.A corporation has an investment opportunity that will involve a time zero $110,
ID: 2652444 • Letter: #
Question
.A corporation has an investment opportunity that will involve a time zero $110,000 depreciable cost for machinery and equipment. It will be depreciated starting in year 1 with an additional machinery and equipment expenditure of $60,000 at the end of year 1. Use 7 year life modified ACRS depreciation for all equipment with the half year convention in the first year. Working capital investment of $30,000 is required at time zero. Income attributed to this investment is $200,000 in year 1 and $300,000 per year in years 2 and 3. Operating costs are estimated to be $150,000 the first year and $180,000 per year in years 2 and 3. The effective tax rate is 40%. It is estimated that the business developed by this investment could be sold at the end of year 3 for $250,000 (including equipment and working capital). What discounted cash flow rate of return would be earned by this investment opportunity? What is the NPV at the 15% DCFROR?
A) DCFROR = 39.26%; NPV @ 15% = +90,628
B) DCFROR = 37.17%; NPV @ 15% = +90,628
C) DCFROR = 39.26%; NPV @ 15% = +77,653
Explanation / Answer
Question
In the given question NPV and DCFROR depends upon following three factors.
(‘1) Present value of Cash Outflow
(‘2) Present value of Cash Inflow
(‘3) Present value of after tax salvage value
WN-1 Present Value of Cash Outflow
Details
Year 0
Year 1
Machinery
110,000
60,000
Working Capital
30,000
Total Outflow
140,000
60,000
PVF @ 15 %
1.00
0.870
PV of cash outflow
140,000
52,714
PV of Cash Outflow= $ 192,174
WN-2 Present Value of Cash Inflow
Details
Year 1
Year 2
Year 3
Income
200,000
300,000
300,000
Operating Cost
150,000
180,000
180,000
Depreciation
24,293
41,633
29,733
Net Income Before Tax
25,707
78,367
90,267
Income After Tax
15424
47020
54160
Cash Inflow ( EAT + Depreciation)
39,717
88,653
83,893
PVF
0.870
0.756
0.658
PF of cash inflow
34,536.70
67034.56
55161.14
PV of Cash Inflow= $ 156,732
WN-3 PV of after tax salvage value
Particulars
Amount
Initial Cost
170,000
Depreciation Claimed
95,659
Net Cost
74,341
Sale Value ( 250,000-30,000)
220,000
Gain
145,659
Tax @ 40 %
58,264
Total Inflow Before tax on sale of machinery and release of working capital
250,000
After Tax Cash Inflow
191,736
PVF @ 15 %
0.658
Present value of inflow
126,070
PV of Inflow = $ 126,070
NPV= Present value of cash inflow – PV of cash outflow
NPV= (126,070 + 156,732) – 192,174
NPV= $ 90,628
Calculation of DCFROR
Discounting Factor
PV of Cash Inflow
PV of Cash Outflow
NPV
37 %
183,471
183,796
-379
36 %
186,709
184,118
2591
DCFROR= 36.87 % at which NPV= 0
DCFROR= 36.87, NPV $ 90628
Details
Year 0
Year 1
Machinery
110,000
60,000
Working Capital
30,000
Total Outflow
140,000
60,000
PVF @ 15 %
1.00
0.870
PV of cash outflow
140,000
52,714
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