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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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    https://brainmass.com/business/capital-budgeting/38950

    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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