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    Ajax new project: calculate cash flows, CAPM, required return, NPV and IRR

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    1. Ajax is considering a new project, Clear Clean (CC). CC requires an additional machine that costs $20 million dollars. It will be fully depreciated to a zero book value on a straight-line basis over 4 years. Each year for 4 years, CC will have revenues of $20 million, variable operating costs of $10 million and fixed operating costs of $2 million. Interest expense is $1,500,000 per year. The tax rate is 40%. The beta of the project is .7, the risk-free rate is 4% and the market risk premium is 10%.

    a) Calculate the investment and annual cash flows.
    b) Use the CAPM to calculate the required return.
    c) Find the NPV and the IRR.
    d) Should Ajax make the investment? Why? In this example, do the NPV rule and the IRR rule give the same result?

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    Solution Preview

    See attached file.

    PART A
    Machine Cost 20000000
    Year 0 Year 1 Year 2 Year 3 Year 4
    Depreciation -5,000,000 -5,000,000 -5,000,000 -5,000,000
    Revenue 20,000,000 20,000,000 20,000,000 20,000,000
    Variable costs -10,000,000 -10,000,000 -10,000,000 -10,000,000
    Fixed ...

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