1. XYZ is considering investing in a new flux capacitor to improve its operational efficiency. Purchase of the new asset will cost $425,000 and it will be used in production for the next five years after which time it will be sold for 15% of its original cost. The asset will be depreciated straight line to zero over the life of the project. The expectation is that pre-tax costs will decrease by $95,000. The capacitor also requires an initial investment in working capital of $30,000. The company's tax rate is 35% and the required return is 11%.
1 What is the after-tax salvage value of the asset?
2 What is the operating cash flow in year 3?
3 What is the project (free) cash flow in the final year of the project?
4 What is the NPV of the project?
5 What is the IRR of the project (to 2 decimal places)?
6 Should XYZ purchase the flux capacitor? Why or why not?
2. The CEO of your firm has asked you to evaluate the launch of a new economy priced widget with an expected project life of four years. Your company cu
ently sells normal priced widgets. The company cu
ently sells 20,000 of normal priced widgets. You hired an external consultant to conduct a study to determine the viability of launching this new product at a cost of $200,000. The new economy widgets will sell for $95 and have a variable cost of $75. The results of the study indicate the company will sell 15,000 of the new economy widgets. The study also indicated that sales of the existing normal priced widgets will fall to 18,000. The existing normal priced widgets sell for $120 and have a variable cost of $95. The fixed costs each year are $50,000. In order to sell the new economy widgets, the company will have to invest in the new production equipment at a cost of $500,000. This equipment will be depreciated to zero over the life of the project. This project will result in a $26,000 decrease in working capital to get started. The tax rate is 40%. The cost of capital is 9%.
7 Calculate the payback period (to 2 decimal places)
8 Calculate the NPV
9 Calculate the IRR (to 2 decimal places)
10 What is the after-tax salvage value of the asset?
11 What is the total capital investment required for this project?
12 What is the operating cash flow?
13 What is the project (free) cash flow in the final year of the project?
3. You have been hired as a consultant to help a client evaluate building a new production facility. The cost of the new facility will be $4,000,000. The client cu
ently owns a piece of property which was purchased ten years ago for $1,000,000. The cu
ent value of the land is $1,500,000. The client plans to construct the new facility on this land. The facility is being evaluated as a four-year project and is being depreciated using the MACRS 5-Year Property Class. The facility will be sold at the end of the project for $2,000,000. The client expects that the new facility will generate operating cash flows of $480,000 per year. The tax rate is 36% and the client’s required return is 12%.
Yea
Percentage
1
20
2
32
3
19.20
4
11.52
5
11.52
6
5.76
14 What is the total capital investment for this project?
15 What is the project (free) cash flow in the final year of the project?
16 What is the after-tax salvage value of the asset?
17 What is the payback period (to 2 decimal places)?
18 What is the NPV
19 What is the IRR (to 2 decimal places)?
20 Should the client pursue the project? Why or why not?