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Calculating the NPV and IRR

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MOMO-FastCopy considers replacing its park of copiers. The management anticipate that new machines will lead to more economic use of raw materials, reduced labor costs, and increased revenues. The firm estimates that the installation of machines will save $50,000 on raw materials and $75,000 on reduced labor costs and will increase revenues by $200,000 (all estimates are per year).

The proposed machines costs $1,000,000. They will have a five year anticipated life and will be depreciated using MACRS depreciation method toward a zero salvage value (MACRS depreciation rates are given below). However, the company will be able to sell them in the after-market for 10% of its original costs at the end of year 5. The company requires a 12% rate of return from its investment and faces a 35% tax rate (the company overall is profitable).

a) Calculate the NPV and IRR for the project. Should the company replace its copiers?
b) The manager raised some concerns about savings and increased revenues projections. Considering one factor at a time, at what level of annual savings of raw materials, annual labor costs savings, and increased revenues the project will break-even (NPV=0)?
c) Looking at percentage difference between the predicted level and critical (break-even) level of each of the three factors, which of them is the most critical?

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Solution Summary

The expert calculates the NPV and IRR.

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Capital Budgeting

1. Front up cost of plant is $100 million. Profits of $30million at the end of every year. Calculate the NPV if the cost of capital is 8%. Should you take the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

2. Upfront costs $5 million. Profits expected $1million for 10 yrs. The company will provide support expected to cost $100,000/year in perpetuity. Assume all profits and expenses occur at end of year.

a. What is the NPV if cost of capital is 6%? Should firm take project? Repeat for discount rates of 2% and 12%.
b. How many IRRs does this investment opportunity have?
c. Can the IRR rule be used to evaluate this investment? Explain

3.Please choose between 2 projects:

Year end Cash Flow ($thousands)
Project 0 1 2 IRR
Playhouse -30 15 20 10.4%
Fort -80 39 52 8.6%

You can undertake only one project. If your cost of capital is 8% use the incremental IRR rule to make the correct decision.

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