A proposed investment has an equipment cost of $1,380,800. The cost will be depr

Question

A proposed investment has an equipment cost of $1,380,800. The cost will be depreciated straight-line to a zero salvage value over its 15 year life. The firm will also use their existing, but currently unused, equipment that has been fully depreciated but has a market value of $37,000. Cash sales will be $223,690 per year and variable costs will run $98,469 per year. Fixed cost is $56,400 per year. The firm will also need to invest $45,331 in net working capital. Marketing research for this project was $46,500 last year and on-going marketing ads will cost $7,000 per year. The appropriate discount rate is 7.4%, and the corporate marginal tax rate is 33% while the average tax rate is 36%. (A.) What are the cash flows for the project? (B.) What is the NPV of this project? (C.) What is the Payback Period? (D.) What is the Profitability Index? (E.) What is the IRR? (F.) Should you accept or reject this project? Assume the payback cutoff is 4 years.

Please show all work using all formulas without excel*

Explanation / Answer

Cashflow in Year 0: -1380800-37000-45331 = -1463131.0

Depreciation = 1380800/15 = 92053.33

From Year1 to Year 15

EBITDA = (223690-98469-56400-7000) = 61821

Taxes will be zero as EBITDA is lower than depreciation expense

We dont need to consider depreciation expense.

PV of annual CF = 61821 * (1 - (1+7.4%)-15) / 7.4% = 549106.57

Working capital will be recovered in Year 15

PV of WC = 45331*(1+7.4%)-15 = 15535.71

Total PV = 549106.57 + 15535.71 = 564642.28

b)

NPV = Intial investment + PV of annual cashflow = -1463131.0 + 564642.28 = -898488.72

c)

payback period = Intial investment / Annual cashflow

                       = 1463131/61821 = 24 years (Never recovered complete investment)

d)

Profitability Index = PV of annual cashflow / Intial investment

                        = 564642.28 / 1463131 = 0.3859

e)

IRR using excel

=RATE(15,61821,-1463131,15535.71) = -4.98%

f)

Reject because negative NPV, Never paidback investment, Profitability Index is less than 1

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