# Calculating NPV and IRR for the given project

Janes, Inc. is considering the purchase of a machine that would cost $430,000 and would last for 6 years, at the end of which, the machine would have a salvage value of $47,000. The machine would reduce labor and other costs by $109,000 per year. Additional working capital of $4,000 would be needed immediately, all of which would be recovered at the end of 6 years. The company requires a minimum pretax return of 17% on all investment projects. (Ignore income taxes in this problem.)

Required:

(a) Determine the net present value of the project.

(b) Calculate the IRR for this project.

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#### Solution Preview

Please refer attached file for better clarity of tables and formulas.

Solution

Cost of Machine=Po=$430,000.00

Salvage Value=S=$47,000.00

Savings in labor and other costs=OS=$109,000.00

Additional Capital required=W=$4,000.00

Cost of capital=17%

Let us summarize the problem.

Year End Cost of machine Cost savings Additiona working capital Salvage Value Net cash flow PV @17%

n Po OS WC S ...

#### Solution Summary

Solution calculates NPV and IRR in the given case.

Calculate NPV, IRR for project; evaluate a capital budgeting

1. Given the following information, calculate the NPV and IRR and give your recommendation on the project (accept/reject).

- Cost of automation system (invoice): $750,000

- Transportation and installation: $150,000

- Training: $100,000

- Firm's WACC: 10%

- Firm's tax rate: 40%

- Capital gains tax: 28%

- Depreciation 5 years, straight line.

- Life of project: 3 years

- Salvage value: $375,000

- Annual cost savings (net operating expenses): $100,000

- Increased annual sales (net operating expenses): $200,000

2. Comprehensive Capital Budgeting Problem

You are asked to evaluate a new product line to replace an existing product that is at the end of its product life cycle. From talking with the engineering, marketing and tax departments, the vendors and banks, you arrive at the following assumptions:

- The new product line will replace the existing product line. Lost revenues from replacing the existing product line are expected to be $1,500,000 in YR 1. The existing product was to be discontinued after YR 1.

- The combined Federal and State tax rate is 38.5%.

- The machinery invoice is $25,000,000, including transportation and installation.

- Depreciation on the machinery is 20 years. Use straight line.

- The total market for the product is $350,000,000 (Yr. 1), and expected to grow at a 10% annual rate over the next five years.

- Your company anticipates gaining an average 1% of the total market share the first year, 5% of the total market share the second year and 8% of the total market share the third year. After year three the line will be salvaged and a new facility is planned to incorporate economies of scale.

- Administrative and operating expenses are estimated to be 40% of annual gross revenues.

- The firm's WACC is 10.3%

- The salvage value at the end of three years is estimated to be $22,500,000.

- Any losses can be used against other gains in the company for tax purposes.

Find the NPV, the IRR, and give your recommendation

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