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# NPV and IRR

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Problem 1: Management is considering purchasing an asset for \$20,000 that would have a useful life of 10 years and no salvage value. For tax purposes, the entire original cost of the asset would be depreciated over 10 years using the straight-line method. The asset would generate annual net cash inflows of \$12,000 throughout its useful life. The project would require additional working capital of \$6,000, which would be released at the end of the project. The company's tax rate is 40% and its discount rate is 13%.
Questions:
1. What is the annual NET (after tax) Cash Inflows? (4 points)
2. What is the annual Depreciation Deduction? (4 points)
3. What is the Net Present Value for this project? (12 points)

Problem 2:
ABC Outlet Store is looking for a new location near a shopping mall. It is considering purchasing a building rather than leasing, as it has done in the past. Three retail buildings near a new mall are available but each has its own advantages and disadvantages. The owner of the company has completed an analysis of each location that includes considerations for the time value of money. The information is as follows
Location A Location B Location C
Internal rate of return 13% 17% 20%
Net present value \$25,000 \$40,000 \$20,000

The owner does not understand how the location with the highest percentage return has the lowest net present value.
Question: Explain to the owner what is (are) the probable cause(s) of the comparable differences (10 points)

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#### Solution Preview

Problem 1: Management is considering purchasing an asset for \$20,000 that would have a useful life of 10 years and no salvage value. For tax purposes, the entire original cost of the asset would be depreciated over 10 years using the straight-line method. The asset would generate annual net cash inflows of \$12,000 throughout its useful life. The project would require additional working capital of \$6,000, which would be released at the end of the project. The company's tax rate is 40% and its discount rate is 13%.
Questions:
1. What is the annual NET (after tax) Cash Inflows? (4 points)

Inflows before depreciation and taxes 12000
Less Depreciation -2000
Inflows before taxes 10000
Less taxes 4000
Inflows after taxes 6000
Annual net after tax Cash Inflows 8000

2. What is the annual Depreciation Deduction? (4 points)
Depreciation = Cost of the Asset / Life of the Asset
= 20000/10
2000

3. What is the Net Present Value for this project? (12 points)

Estimating Initial cash outflows

Investment in Assest: 20000