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Florida Car Wash is considering a new project, which requires an initial investm

ID: 2726364 • Letter: F

Question

Florida Car Wash is considering a new project, which requires an initial investment of $60,000. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over its 3-year life to zero salvage value. The equipment can be sold for $10,000 at the end of year 3. With the new equipment, the company is expected to wash 2,800 cars per year for all 3 years. The price per car will be $25 for the first year, and growing at a constant rate of 5% due to inflation. . The variable cost is 20% of the revenue, and the fixed cost is $10,000 each year. Suppose Florida Car Wash allows its customers to pay their bills with an average 1-month delay, and its inventories are 15% of next year’s revenue. If the opportunity cost of capital is 9%, corporate tax rate is 35%, and capital gain tax is 15%.

What is the project’s NPV? Should you accept the project based on its NPV?

What is the project’s IRR? Will your answer change based on the IRR method?

How much would the project’s NPV change if the number of cars washed reduces to half?

Please help me understand with use of the following categories:

Year 0

Year 1

Year 2

Year 3

Cost for new machine

Working Capital

Change in Working Capital

Revenues

Expense

Depre

Pretax Profit

Taxes

Profit

Net-of-tax Proceeds

Cash Flows

Discounted Cash Flows

Year 0

Year 1

Year 2

Year 3

Cost for new machine

Working Capital

Change in Working Capital

Revenues

Expense

Depre

Pretax Profit

Taxes

Profit

Net-of-tax Proceeds

Cash Flows

Discounted Cash Flows

Explanation / Answer

CALCULAITON OF NPV:

_____________________________________________________________________________________________

YEAR                                                             0                                 1                            2                    3                        

1. INITIAL INVESTMENT                           $60,000                           --                              --                      --

2. WORKING

     (RECEIVABLES+INVENTORIES)                                --           16,858                    17,701            18.586             

3. CHANGE IN WORKING CAPITAL                                              16,858                         843                 885        

4. REVENUES (2800 X 25)+5% EVERY YEAR         -                    70,000                    73,500            77,175

5. EXPENSES(VARIABLE@20%+FIXED)            --                        24,000                    24,700            25,435    

6. DEPRECIATION (60,000/3)                                -                        20,000                    20,000            20,000

7. PRETAX PROFITS (4-5-6)                                                           26,000                    28,800            31,740

8. TAX @35%(35% X 7)                                         --                         9,100                     10,080            11,109

9. PROFITS AFTER TAX (7-8)                                                         16,900                     18,720            20,631

10. NET OF THE TAX PROCEEDINGS

      (SALE OF ASSET)     (10,000-15%)                                                   --                           --                 8,500

11. CASH FLOWS (9+6-3+10)                        --                               20,042                      37,877            48,246

12. PRESENT VALUE FACTOR @9%                                             0.9174                      0.8417            0.7722

13. DISCOUNTED CASH FLOWS             (60,000)                         18,387                      31,881            37,256    

CALCULATION OF NPV:

______________________________________________________________________

TOTAL PRESENT VALUE OF CASH INFLOWS ( 18,387+31,881+37,256)         =      $87,524

LESS: INITIAL INVESTMENT                                                                                =        60,000

DECISION: SINCE, NPV IS POSITIVE PROJECT WILL BE ACCEPTED

CALCULATION OF IRR:

___________________________________________________________________________________________

YEARS                                                     1                                     2                                   3              TOTTAL          

1. DISCOUNTED CASH FLOWS            20,042                           37,877                        48,246

2. PRESENT VALUE FACTOR

     @30%(TRIAL & ERROR)                 0. 7692                            0.5917                        0.4552

3. PRESENT VALUE (1X2)                  15,416                            22,418                        21,962

4. TOTAL PRESENT VALUE                                                                                                                       59,796     

5. LESS: INITIAL INVESTMENT                                                                                                                  60,000

6. NPV   (4-5)                                                                                                                                                   (204)  

CALCULATION OF IRR:

PRESENT VALUE REQUIRED        = 60,000

PRESENT VALUE @9%                  = 87,524

PRESENT VALUE @30%                = 59,796

BY INTERPOLATION

IRR = LOWER RATE+ (PRESNT VALUE AT LOWER RATE - PRESENT VALUE REQUIRED/PRESENT VALUE AT LOWER RATE - PRESENT VALUE AT HIGHER RATE) X DIFFERENCE BETWEEN LOWER AND HIGHER RATE

IRR = 9% + (87254 - 60,000)/87,254 - 59,796) X 21%

       = 9% + (27,254/27,458) X 21

       = 9% + (0.99 X 21)

       =9%+20.79%

      = 29.79%     

DECISION : SICE,PROJECT IRR 29.79% IS GREATER THAN OPPORTUNITY COST 9%, PROJECT WILL BE ACCEPTED

CALCULATION OF NPV IF CAR WASHES ARE REDUCED TO HALF I.E 1400

________________________________________________________________________________________

YEARS                                                               0                              1                        2                        3          

1. INITIAL INVESTMENT                                  60,0000                      ---                        --                              

2. WORKING CAPITAL

   (RECEIVABLE + INVENTORIES)                        --                    8,430                      8,851                 9,294

3. CHANGE IN WORKING CAPITAL                       --                    8,430                         421                    443

4. REVENUES ( 14,00 X 25) + 5%                                              35,000                     36,750              38,588

5. EXPENSES (VARIABLE @20%+FIXED)                                 17,000                     17,350              17,718

6. DEPRECIAITON (60,000/3)                                                      20,000                     20,000              20,000

7. PRETAX PROFIT                                                                      (2,000)                      (600)                    870

8. TAX @ 35%                                                                                NIL                               NIL                  305

9. PROFITS AFTER TAX                                                              (2,000)                      (600)                    565

10. NET OF TAX PROCEEDS

       (SALE OF ASSET)                                                                       --                             --                     8,500

11. CASH FLOWS (9+6-3+10)                      --                            28,430                      18,979                20,122

12. PRESENT VALUE FACTOR@9%                                         0. 9174                     0.8417               0.7722

13. DISCOUNTED CASHFLOWS (11 X 12)                                 26,082                      15,975             15,538

TOTAL DISCOUNTED CASH FLOWS (26,082 + 15,875+15,538)         =       57,495

LESS: INITIAL INVESTMENT                                                                  =      60,000

NPV                                                                                                                   (2,505)