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Economic Profit and NPV for Steele Electronics

Economic Profit and NPV

Steele Electronics is considering an investment in a new component that requires a $100,000 investment in new capital equipment, as well as additional net working capital. The investment is expected to provide cash flows over the next five years. The anticipated earnings and project free cash flows for the investment are found in the table (See Excel attachment).

a) Assuming a project cost of capital of 11.24%, calculate the project's NPV and IRR.

b) Steele is considering the adoption of economic profit as a performance evaluation tool. Calculate the project's annual economic profit using the invested capital figures found in the table (Recall that the invested capital in the project is equal to net fixed assets plus net working capital) (see excel attachment for table). How are your economic profit estimates related to the project's NPV?

c) How would your assessment of the project's worth be affected if the economic profits in 2006 and 2007 were both negative? (no calculations required)

See attached excel file

Attachments

Solution Preview

See the attached file. Thanks

PROBLEM 9-5

Given
Tax Rate 30.00%
Capital Expenditures in 2005 ($100,000) and none thereafter
Weighted Average Cost of Capital 0.1124

Project Pro Forma Income Statements
Year
2006 2007 2008 2009 2010
Revenues $100,000.00 $105,000.00 $110,250.00 $115,762.50 $121,550.63
Less: Cost of Goods Sold (40,000.00) (42,000.00) (44,100.00) (46,305.00) (48,620.25)
Gross Profit $60,000.00 $63,000.00 $66,150.00 $69,457.50 $72,930.38
Less: Operating Expenses (20,000.00) (21,000.00) (22,050.00) (23,152.50) (24,310.13)
Less: Depreciation Expense (20,000.00) (20,000.00) (20,000.00) (20,000.00) (20,000.00)
Net Operating Income $20,000.00 $22,000.00 ...

Solution Summary

The solution determines the economic profit and the NPV for Steele Electronics. The IRR for the project is determined.

$2.19