FITCO Inc. is a Pharmaceutical company which is considering investing in a new e
ID: 2713762 • Letter: F
Question
FITCO Inc. is a Pharmaceutical company which is considering investing in a new equipment for the production of pain-reliever machine for individuals who suffer from cardio vascular diseases. The new equipment will cost $2,000,000, and an additional $100,000 is needed for installation. The equipment which falls into the MACRS 5-yr class, would be sold after 5 years for $150,000. The equipment will generate additional annual revenues of $965,000, and will have annual operating expenses of $300,000. An inventory investment of $60,000 is required during the life of the project. FITCO is in the 30 percent tax bracket, and has the same risk as the firm's existing assets. Its existing cost of capital is 15 percent.
(a) Calculate the initial outlay of the project (no. units and points)
(b) Calculate the annual after-tax operating cash flow for years 1 to 5 (no. units and points)
(c) Determine the terminal year non-operating cash flow in year 5 (no. units and points)
(d) What is the project NPV (rounded to the nearest hundred)
(e) What is the estimated IRR of the project?
(f) Should the project be accepted based on the IRR criterion?
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Explanation / Answer
a) Initial outlay of the project -
Cost of new equipment $2000000
(+) Installation $100000
(+) Cost of inventory investment $60000
Initial outlay $2160000
b) Annual after tax operating cash flow -
Particulars 1 2 3 4 5
Cash revenues $965000 $965000 $965000 $965000 $965000
(-) Cash expenses $300000 $300000 $300000 $300000 $300000
(-) depreciation 20% of ($2000000 - $150000) $370000 $370000 $370000 $370000 $370000
Net income before tax $295000 $295000 $295000 $295000 $295000
(-) 30% tax $88500 $88500 $88500 $88500 $88500
Net income after tax $206500 $206500 $206500 $206500 $206500
(+) depreciation $370000 $370000 $370000 $370000 $370000
Cash flow after tax $576500 $576500 $576500 $576500 $576500
c) Terminal year non-operating cash flow in the year 5 -
After tax salvage value ($150000 - 30% of $150000) $105000
(+) Return of net working capital $576500
$681500
d) NPV = Initial investment + CF1 + CF2 + CF3 + CF4 + CF5
(1 + K)1 (1 + K)2 (1 + K)3 (1 + K)4 (1 + K)5
= $2160000 + $576500 + $576500 + $576500 + $576500 + $576500
(1 + 0.15)1 (1 + 0.15)2 (1 + 0.15)3 (1 + 0.15)4 (1 + 0.15)5
= $2160000 + $501304 + $436742 + $379276 + $329429 + $286816
= $4093567
e) IRR -
NPV = Initial investment + CF1 + CF2 + CF3 + CF4 + CF5
(1 + r)1 (1 + r)2 (1 + r)3 (1 + r)4 (1 + r)5
0 = $2160000 + $576500 + $576500 + $576500 + $576500 + $576500
(1 + r)1 (1 + r)2 (1 + r)3 (1 + r)4 (1 + r)5
-2160000 = (1+r)4 *576500 + (1+r)3 * 576500 + (1 + r)2 * 576500 + (1 + r)1 * 576500 + 576500
(1 + r)5
-576500 = (1 + r)5 * 2160000 + (1+r)4 *576500 + (1+r)3 * 576500 + (1 + r)2 * 576500 + (1 + r)1 * 576500
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