iN \'06 ABC Company is considering the purchase of an asset which would cost $10
ID: 2744117 • Letter: I
Question
iN '06 ABC Company is considering the purchase of an asset which would cost $100,000. The '06 information includes the impact of this asset. All changes from '05 to '06 can be attributed to the benefits of this asset. The asset would be depreciated based on 7 year MACRS The company's financial situation is as follows: Revenue is expected to increase by 6% each and every year (after year 1); Expenses are expected to increase by 1% each and every year (after year 1). The company's cost of capital is 10%. the company's internal guidelines require that in order to be approved all projects must provide a return greater than cost of capital plus 5%. The company evaluates only the first three years of the life of a project. The company is in the 40% tax bracket. Based on NPV - should the asset be purchased? What is the IRR of this project? Provide proofExplanation / Answer
IRR of the prject is 15% because at this rate the NPV is aprroximate "0".
Working:
12/31/05' 12/31/06' Year-1 Year-2 Year-3 Total Revenue 245000 350000 Increase in revenue 105,000 111,300 117,978 expense 200000 250000 Increase in expense 50,000 50,500 51,005 Depreciation 14,290 24,490 17,490 Income before tax 40,710 36,310 49,483 Less: Tax 16,284 14,524 19,793 Net income 24,426 21,786 29,690 Add: Dep 14,290 24,490 17,490 Cash flow 38,716 46,276 47,180 Discount factor @15% 0.870 0.756 0.658 Present value 33,666 34,991 31,021 99,679 Less: Initial Investment 100000 Net Present value (321) In the first 3 year of life the project has no profit no loss, but after 3 years project will generate positive NPV.Related Questions
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