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# Net present value of this investment proposal

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(See attached file for full problem description)

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1. The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be \$120,000. Of this amount, \$70,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years. At the end of six years, the non-depreciable assets will be sold for \$50,000. The depreciated assets will have zero resale value.
The contract will require an investment of \$55,000 in working capital at the beginning of the first year, and, of this amount, \$25,000 will be returned to the Spartan Technology Company after six years.
The investment will produce \$50,000 in income before depreciation and taxes for each of the six years. The corporation is in a 40 percent tax bracket and has a 10 percent cost of capital.
BELOW IS QUESTION 8 WITH ANSWER AS AN EXAMPLE
The Acme Corporation is considering the purchase of an additional lathe to handle periodic overload conditions in the shop. By reducing overtime premiums, purchase of this lathe will result in cash savings of \$20,000 per year before taxes. The new lathe would cost \$50,000 and would have a useful life of 5 years. The lathe would be depreciated straight line to a zero salvage value over its useful life of 5 years. (It really wouldn't, but let's say it would. It is easier that way!)

Using a separate piece of paper or a computer spreadsheet, calculate the after-tax cash flows for this investment proposal using the method described in the discussion material for this lesson. That is, calculate the after-tax cash flows as if there were no non-cash expenses. Then adjust these after-tax cash flows for the tax credits resulting from the non-cash tax shields. Calculate the net present value of this investment proposal using a 15% discount rate. Acme's marginal tax rate is 40%.
Problem 8
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
EBIDT 20,000 20,000 20,000 20,000 20,000
(1)After tax @ 40% tax rate 12,000 12,000 12,000 12,000 12,000

Depreciation 10,000 10,000 10,000 10,000 10,000
(2)Depreciation tax credit 4,000 4,000 4,000 4,000 4,000

Cashflow (1) + (2) 16,000 16,000 16,000 16,000 16,000

Investment -50,000
NPV= 3,634 @ 15% cost of capital
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#### Solution Summary

This explains the computation of net present value of investment proposal

\$2.19
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## Capital Budgeting

You are presented with a proposal for a project. The bottom line is that is claimed that if you invest 20 million in a project for this year, you will receive 5 million, 18 million, and 12 million over the following three years

a. Set up a worksheet that will tell you both the net present value of this project assuming a 12% discount rate and the internal rate of return for this project.

b. You decide that most likely the project will cost 24 million this year and return 4 million, 14 million and 10 million over the next three years. What would be the net present values and the internal rate of return?

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