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# Net investment, net cash flows, net present value and the Internal Rate of Return

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1. The capital budgeting department is contemplating whether to purchase a piece of equipment. The new piece of equipment costs \$900,000. The equipment currently being used by the firm would be replaced by the new and would be sold for \$100,000 which is the firm's book value for the asset. The estimated useful life of the new equipment is 3 years. The firm's capital gain tax rate is 20% and their ordinary tax rate is 40%. The new equipment is not expected to have a salvage value at the end of its useful life and the firm uses straight-line depreciation.

Estimated Earnings:

Year Without the new equipment With the new equipment
1 \$500,000 \$1,200,000
2 \$700,000 \$1,500,000
3 \$900,000 \$1,900,000

Depreciation Information
Year Without the new equipment With the new Equipment
1 \$200,000 \$500,000
2 \$250,000 \$550,000
3 \$300,000 \$600,000

Calculate the net investment, net cash flows, the net present value and the Internal Rate of Return on this project assuming an 8% cost of capital.

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#### Solution Preview

1. Net Investment = \$900,000 - 100,000*(1-40%) = \$840,000

2. Net Cash Flows = Increase in cash flow*(1-t) + Increase in depreciation * t
Year Cash flow:
1 (1,200, ...

#### Solution Summary

The solution shows all the calculations to arrive at the correct answers.

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