RSM Co is considering a project which will require the purchase of $2.7 million
ID: 2798244 • Letter: R
Question
RSM Co is considering a project which will require the purchase of $2.7 million in new equipment. The equipment will be depreciated straight-line to a book value of $1 million over the 5-year life of the project. Annual sales from this project are estimated at $2,950,000. The variable cost is 40% of the annual sales and there is an annual fixed cost of $200,000. Sway's Back Store will sell the equipment at the end of the project for 30% of its original cost. New net working capital equal to 15% of sales will be required to support the project. All of the new net working capital will be recouped at the end of the project. The firm’s WACC is 12% per year. The tax rate is 40%.
Please calculate the project NPV, IRR, Discounted Payback Period and Modified IRR (reinvestment return is 10%).
Please answer without using Excel. Thank you.
Explanation / Answer
Cost of equipment 2700000 SLM Salvage value (for depreciation ) 1000000 Useful life 5 Annual sales 2950000 VC 40% Annual fixed cost 200000 Salvage value (sale) 30% of cost NWC 15% of sales WACC 12% Tax rate 40% NPV IRR Disc. PB MIRR (i) NPV = Years 0 1 to 5 5 Cost of equipment -2700000 Net working capital -442500 Recovery of Net working capital (442500 x 5) 2212500 Sales 2950000 Variable costs 1180000 Contribution 1770000 Fixed Cost 200000 Depreciation (2.7-1)/5 340000 EBT 1230000 Tax 492000 PAT 738000 Depreciation 340000 CFAT 1078000 Post Tax salvage value (2.7 x 30% x (1- 0.4) 486000 Total cash flows -2700000 635500 2698500 PV factors 1 3.6048 0.567427 PV of cash flows -2700000 2290835.28 1531201 NPV = 1122036.65 (ii) IRR - Using linear interpolation - r= NPV 23% 40117.56 r 0.00 24% -34828.97 r-23/24-23 = (0-40117.56)/(-34828.97-40117.56) r-23 = 0.5353 x 1 r = 23.54% (Approx) (iii) Discounting payback - Year cash flows PV factors @ 12% PV of cash flows Cumulative cash flows 0 -2700000 1 -2700000 -2700000 1 635500 0.8928571 567410.71 -2132589.286 2 635500 0.7971939 506616.71 -1625972.577 3 635500 0.7117802 452336.35 -1173636.229 4 635500 0.6355181 403871.74 -769764.4902 5 3334000 0.5674269 1891801.1 1122036.647 Payback = 4 + (769764.4902/1891801.1) 4.406895 (iV) MIRR = [(Terminal value/ Initial investment)^(1/n)] -1 Terminal value(At t=5) Cash flows Future value Annual cash flows (See NOTE ) 4037234.50 Recovery of NWC 2212500 Salvage value(Post Tax) 486000 6735734.497 Initial Investment (T=0) 2700000 Project life (n) 5 MIRR = 20.0616% NOTE - Future value of Annual cash flows Year Cash flow Compounding factor Future value at T=5 1 635500 (1.12)^(5-1) 1.5735194 999971.55 2 635500 (1.12)^(5-2) 1.404928 892831.74 3 635500 (1.12)^(5-3) 1.2544 797171.20 4 635500 (1.12)^(5-4) 1.12 711760.00 5 635500 (1.12)^(5-5) 1 635500.00 4037234.50 Assuming cash flows occur at the end of year. Project is acceptable as it has a positive NPV and IRR more then WACC. Please provide feedback…. Thanks in advance…. :-)
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