# 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.

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 ___________________________%

https://brainmass.com/business/capital-budgeting/39064

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