\"A manufacturing company has just received an order with the following financia
ID: 2789912 • Letter: #
Question
"A manufacturing company has just received an order with the following financial data. All dollar values are given in constant dollars, and inflation will impact the annual revenue, annual operating cost, and the salvage value. The two-year project requires immediately purchasing equipment for $65,000. The equipment falls into the MACRS 5-year class. The machine will be sold for $16,000 at the end of two years. The project will bring in additional annual revenue of $92,000, but it is expected to incur an additional annual operating cost of $25,000. The firm expects a general inflation rate of 3% per year during the project period. The firm's tax rate is 38%, and its market interest rate is 17%. What is the net present worth of this project?"
Explanation / Answer
Depreciation: MACRS (Modified Accelerated Cost Recovery System) 5-year class depreciation
The depreciation rates under the MACRS 5-year asset class are: 20%, 32%, 19%, 12%, 11%, 6%
Year 0: -$65000(purchase of equiptment)---puchase=-$65000
Year 1: net income = $(92000-25000-(0.2*65000))=$54000
after tax: $54,000*(1-0.38)= $33,480
Year 2: net income= $(92000+16000-25000-(0.32*65000))=$62,200
after tax: $62,200(1-0.38)=$38,564
Let the market interest rate = nominal cost of capital for the company
As, all the values are calculated in real terms. They have to be discounted in real term. Hence, real discount rate = nominal - inflation = 17% - 3% = 14%
So, NPV = net present value = $(-65000+((33,480)/(1+0.14))+((38,564)/(1+0.14)^2))
=-$5,957.833
So, net preesent worth of this project is negative.
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