Test Version B 20) Run Co. is considering a new project. The key data about the

Question

Test Version B 20) Run Co. is considering a new project. The key data about the project are provided below. The equipment for the project would cost $90,000 and be depreciated by the straight-line method over the project's 3-year life to zero. The equipment will be sold for $20,000 at the end of the project. Working capital would increase by $5,000 initially, but it would be fully recovered at the end of the project's 3-year life. The company owns the building that would be used for the project. If them anagement decided not to undertake the project, the building could be leased to a thifd party for the next three years for $20,000 (after-tax) per year. p CSt Over the past twe-years-the company spent $75,000 in research and developing costs. Annual sales revenue of the project is $200,000 per year. Annual operating cost of the -project is 50% of the sales revenue. Interest expense is $3,000 peryear. The company's cost of capital is 10%. Its tax rate is 40%. What is the project's NPV and IRR? (5 points) 2 3

Explanation / Answer

If discount rate is 20%, NPV = $41500

If discount rate is 21%, NPV = -$584.1134619

For 1% increase in rate, NPV decreases by $42084.1134619 (41500+584.1134619)

For how much increase in rate, NPV decreases by $41500?

Answer is 0.98612 (41500/42084.1134619)

IRR = 20+0.98612 = 20.98612%

Annual Cash Flow after tax: Particulars Amount ($) Sales Revenue 200000 Less: Operating Cost 50% of $200000 100000 Operating Profit 200000-100000 100000 Less: Interest Expense 3000 Earnings before tax 100000-3000 97000 Less: Taxes 97000*40% 38800 Earnings after tax 97000-38800 58200 Depreciation 90000/3 30000 Cash Flow after tax 58200+30000 88200 Terminal Cash Flow: Sales Value 20000 Book Value 0 Profit on sale 20000-0 20000 Tax on Profit 20000*40% 8000 Sale Value after tax 20000-8000 12000 Net Present Value: Year Cash Flow PVF/FVF (10%) PV of CF -2 -37500 1.21 -45375 -1 -37500 1.1 -41250 0 -90000 1 -90000 1 88200 0.909090909 80181.81818 2 88200 0.826446281 72892.56198 3 88200 0.751314801 66265.96544 3 12000 0.751314801 9015.777611 51731.12322 NPV at various rates Year Cash Flow PVF/FVF(20%) PV of CF PVF/FVF(21%) PV of CF -2 -37500 1.4400 -54000 1.4641 -54903.75 -1 -37500 1.2000 -45000 1.21 -45375 0 -90000 1.0000 -90000 1 -90000 1 88200 0.833333333 73500 0.826446281 72892.56198 2 88200 0.833333333 73500 0.683013455 60241.78676 3 88200 0.833333333 73500 0.56447393 49786.60063 3 12000 0.833333333 10000 0.56447393 6773.687161 41500 -584.1134619

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