PET 446 Homework #3 Fall 2018 Due: Wednesday, September 19 at 11:55 p.m Payback,
ID: 2819152 • Letter: P
Question
PET 446 Homework #3 Fall 2018 Due: Wednesday, September 19 at 11:55 p.m Payback, NPV, and IRR (20 points total) The Young Exploration Company is considering investing in a processing plant at a cost of S800,000. The plant is expected to increase revenues but will incur additional production costs. I is estimated the plant will sell an additional 4,000 units per year. The forecasted selling price and costs for the project are as follows: $70.00 It is believed the plant will have a useful life of 8 years and a salvage value of $50,000 at the end of its 8-year life. The Company will depreciate this asset under the MACRS method to a salvage value of $O for income tax purposes. The asset qualifies as a seven-year asset with the following percentages: 14 29% 24 49% 1749% 1249% 892% 8 93% 446% The Company has an income tax rate of 21 percent and a hurdle rate of 18 percent on these type of projects Required: 1. Calculate the relevant cash flows for this investment 2. Calculate the undiscounted payback for this project 3. Calculate the NPV of this project 4. Calculate the IRR of this project 5. Should Young purchase the machine (explain)? 6. How would your analysis change if Young determined that this project was an above average risk project?Explanation / Answer
tax rate=21%
Cash flow in year 0:= -800000
Cah flow in year 1=(4000*(70-5)-30000-14.29%*800000)*(1-21%)+14.29%*800000=205707.20
Cah flow in year 2=(4000*(70-5)-30000-24.49%*800000)*(1-21%)+24.49%*800000=222843.20
Cah flow in year 3=(4000*(70-5)-30000-17.49%*800000)*(1-21%)+17.49%*800000=211083.20
Cah flow in year 4=(4000*(70-5)-30000-12.49%*800000)*(1-21%)+12.49%*800000=202683.20
Cah flow in year 5=(4000*(70-5)-30000-8.93%*800000)*(1-21%)+8.93%*800000=196702.40
Cah flow in year 6=(4000*(70-5)-30000-8.92%*800000)*(1-21%)+8.92%*800000=196685.60
Cah flow in year 7=(4000*(70-5)-30000-8.93%*800000)*(1-21%)+8.93%*800000=196702.40
Cah flow in year 8=(4000*(70-5)-30000-4.46%*800000)*(1-21%)+4.46%*800000=189192.80
cost of capital=18%
NPV=38305.44
IRR=19.57%
Undiscounted Payback=3.79 years
Purchase the machine as NPV is positive and IRR is more than the hurdle rate
If it is above average risk project then hurdle rate would increase due to which acceptability of project might vanish.
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