You can use a WACC of 10% for the computation of the NPV and comparison for IRR.
ID: 2709136 • Letter: Y
Question
You can use a WACC of 10% for the computation of the NPV and comparison for IRR."
“I’ve got the information I need from Luke and James,” you say. "Does this look right to you? Here’s what they gave me,” you say, as you hand a sheet of paper to Mary.
“Let’s look at this now while we’re together,” she says.
The information you hand to Mary shows the following:
Initial investment outlay of $30 million, consisting of $25 million for equipment and $5 million for net working capital (NWC) (plastic substrate and ink inventory); NWC recoverable in terminal year
Project and equipment life: 5 years
Sales: $25 million per year for five years
Assume gross margin of 60% (exclusive of depreciation)
Depreciation: Straight-line for tax purposes
Selling, general, and administrative expenses: 10% of sales
Tax rate: 35%
You continue your conversation.
“It looks good,” says Mary. “Use this information from Luke and James to compute the cash flows for the project.”
“No problem,” you say.
“Then, compute NPV and IRR of the project using the Excel spreadsheet I sent earlier today,” says Mary. “Use the IRR financial function for the computation of IRR.”
“Okay,” you say. "I’ll submit my Excel file showing the computation of cash flows, NPV, and IRR by the end of week so you can look at it over the weekend.”
Explanation / Answer
Initial investment outlay = $ 30,000,000
Annual Depreciation = (Equipment Cost-salvage value)/Useful Life
Annual Depreciation = (25000000-0)/5
Annual Depreciation = 5000000
Annual cash Flow = (Sale * gross margin - Selling, general, and administrative expenses)*(1-tax rate ) + Annual Depreciation *tax rate
Annual cash Flow = (25000000*60% - 25000000*10%)*(1-35%) + 5000000*35%
Annual cash Flow = $ 9875000
Terminal Cash Flow = working capital recovered
Terminal Cash Flow = 5000000
NPV = -Initial investment outlay + Annual cash Flow *PVIFA(rate,nper) + Terminal Cash Flow*PVIF(rate,nper)
NPV = -30000000 + 9875000*PVIFA(10%,5) + 5000000*PVIF(10%,5)
NPV = -30000000 + 9875000*3.79078677 + 5000000*0.62092132
NPV = $ 10,538,625.96
Year 5 cash flow = Annual Cash Flow + Terminal cash flow
Year 5 cash flow = 9875000+5000000
Year 5 cash flow = $ 14875000
IRR = irr(values)
IRR = irr({-30000000,9875000,9875000,9875000,9875000,9875000,14875000})
IRR = 25.63%
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