NEW PROJECT ANAYLSIS

Holmes Manufacturing is considering a new machine that costs $250,000...

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NEW PROJECT ANAYLSIS

Holmes Manufacturing is considering a new machine that costs $250,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the
 3- year MACRS method to depreciate the machine, and management thinks the machine would have a value of $23,000 at the end of its 5-year operating life.
 The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. Net operating working capital would increase by $25,000
 initially, but it would be recovered at the end of the project’s 5-year life. Holmes’s marginal tax rate is 40%, and a 10% WACC is appropriate for the
 project.

a. Calculate the project’s NPV, IRR, MIRR, and payback.

b. Assume management is unsure about the $90,000 cost savings – this figure could deviate by as much as plus or minus 20%. What would the NPV be under each
 of these situations?

c. Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine’s salvage value, and the net operating
 working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis.

Scenario

Probability

Cost Savings

Salvage Value

Worst Case

35%

72,000

18,000

Base Case

35%

90,000

23,000

Best Case

30%

108,000

28,000

Calculate the project’s expected NPV, its standard deviation, and its coefficient of variation.

Would you recommend that the project be accepted? Why or why not?

David · Accepted Answer

Solution:
Solution:
c.
Worst-case scenario:
0
1
2
3
4
5
Initial investment
($250,000)
Net oper. WC
(30,000)
Cost savings
$72,000
$  72,000
$72,000
$72,000
$72,000
Depreciation
  82,500
  112,500
  37,500
  17,500
           0
Oper. inc. before taxes
($10,500)
($  40,500)
$34,500
$54,500
$72,000
Taxes (40%)
  (4,200)
  (16,200)
  13,800
  21,800
  28,800
Oper. Inc. (AT)
($  6,300)
($  24,300)
$20,700
$32,700
$43,200
Add: Depreciationa
  82,500
  112,500
  37,500
  17,500
           0
Oper. CF
$76,200
$  88,200
$58,200
$50,200
$43,200
Return of NOWC
$30,

NEW PROJECT ANAYLSIS Holmes Manufacturing is considering a new machine that costs $250,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the 3- year MACRS method to...

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