1. The manager of PPO Inc. plans to manufacture engine blocks for classic cars f
ID: 2720653 • Letter: 1
Question
1. The manager of PPO Inc. plans to manufacture engine blocks for classic cars from the 1960s. The revenue from the blocks will be $750,000 per year for each of the next 4 years. The equipment will cost $800,000 depreciated using a 3 year MACRS life. There will be a change in net operating working capital of $10,000. Assume a zero salvage value. Operating costs for each of the 4 years will be $250,000. Assume a 40% tax rate and a 12% discount rate (cost of capital). a. What are the cash flows for years 0 through 4? b. Calculate the net present value, the IRR, MIRR and Profitability Index, Payback for the project. c. Will you accept the project?
Explanation / Answer
Cash flows
Initial cash flow
Cost of equipment $ 800,000
Net working capital $ 10,000
$ 810,000
Subsequent cash flow T1 T2 T3 T4
Revenue –Operating expenses 500,000 500,000 500,000 500,000
Depreciation 166,650 222,250 74,050 37,050
Profit before tax 333,350 277,750 425,950 462,950
Tax 133,340 111,100 170,380 185,180
PAT 200,010 166,650 255,570 277770
Depreciation 166,650 222,250 74,050 37,050
Cash flow after tax 366,660 388900 181,520 240,720
Working capital release 10,000
250,720
PVF AT 12% .893 .797 .712 .636
Present value 327427 309,953 129,242 159,458
PV of cash inflow 926,080
PV of cash out flow 810,000
NPV 116,080
PROFITABILTY INDEX = 926,080
810,000
=1.1433
IRR
NPV at 20 % -8729
IRR by Interpolation 12%+ 116080 * (20-12)
116080+8729
19.44%
MIRR
TERMINAL VAUES AT 12%
T1 366,660(1.12)3 515,130
T2 388,900(1.12)2 487,836
T3 181,520 (1.12) 203,000
T4 250,720 250,720
Total terminal value 1,456,686
810,000 (1+r)4 = 1,456,686
MIRR = 15.8
PAYBACK PERIOD Cumulative cash flow
T1 366,660 366,660
T2 388,900 755,560
T3 181250 936,810
Pay back period is 2 + 810,000-755560
181,250
2.30 year
Project should be accepted as it is positive NPV PI ratio is greater than 1 and IRR is greater than cost of capital
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