Explore BrainMass

Explore BrainMass

    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.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    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 b the firm would be replaced by the new and would e sold for $100,000 which is the firms book value fort he 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. (25 points)

    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, -500,)*(1-40%) + (500, - 200,)*40% = 540,000
    2 (1,500,-700,)*(1-40%) + (550, - 250,)*40% = 600,000
    3 (1,900, -900,)*(1-40%) + (600, - 300,)*40% = 720,000

    3. Net Present Value
    The present of each cash flow is computed by:
    PVi = CF / (1+r)^i
    Where r = 8% and i is the number of years.
    By a financial calculator, NPV = $745,963

    4. Internal Rate of Return
    By a financial calculator, IRR = 38.9%, which is higher than the cost of capital.

    2.How would your answer to number 1 change if the existing asset that is being replaced was sold at $125,000. The assets original purchase price was $500,000 Remember the assets book value is $100,000. Assume all other facts are the same as in question number 2. ( make sure to calculate the net investment, net cash flows, net present value and IRR.)
    Net Investment $_______________________________
    Net Cash Flows $_______________________________
    Net Present Value $_______________________________
    Internal Rate of Return ___________________________%

    © BrainMass Inc. brainmass.com June 3, 2020, 5:48 pm ad1c9bdddf
    https://brainmass.com/business/capital-budgeting/39064

    Solution Summary

    You will find the answer to this puzzling question inside...

    $2.19

    ADVERTISEMENT