Case95QuestionsPalmer1
QUESTIONS
1. Table 1 contains the complete cash flow analysis 6 on GP Manufacturing’s basic information. Explain the inputs into 1) the net initial investment outlay at year 0, 2) the depreciation tax savings in each year of the project’s economic life, and 3) the project’s incremental cash flows?
1) $302,040 net initial investment includes:
($285,000) delivered cost
($18,000) installation cost
($2,500) removal cost
$4,000 current market value
($1,440) tax on proceeds
2) For year 1 the new system depreciated by 20 percent. Multiply that by the net initial investment and you get the total amount depreciated after 1 year, equal to $60,588. With a 36 percent tax rate you get the depreciated tax savings of $21,812.
Year 2- 32% depreciated
Year 3- 19% depreciated
Year 4- 12% depreciated
Year 5- 11% depreciated
Year 6- 6% depreciated
3) Incremental cash flows: add depreciation tax saving of each year and add after tax cost saving of each year. Year 8 has a cash flow that consist of after tax cost savings and salvage value of the system.
2. What is the project’s NPV? Explain the economic rationale behind the NPV. Could the NPV of this particular project be different for GP Manufacturing than for one of Chino Material Systems Inc.’s other potential customers? Explain.
NPV = $20,578
NPV is a measure of profitability of an investment. If NPV is positive, the company should accept the project. The NPV would be the same for everyone if values were the same because it is just an estimate of future cash flows. The only way it could change is if they used a different cost of capital.
3. Calculate the proposed project’s IRR. Explain the rationale for using the IRR to evaluate capital investment projects. Could the IRR for this project differ for GP Manufacturing versus for another customer?
IRR = 14.32%
The higher the rate, the better. IRR is a good indicator of whether a company should accept a long term investment. Ideally, you want the IRR to be greater than the
1. Table 1 contains the complete cash flow analysis 6 on GP Manufacturing’s basic information. Explain the inputs into 1) the net initial investment outlay at year 0, 2) the depreciation tax savings in each year of the project’s economic life, and 3) the project’s incremental cash flows?
1) $302,040 net initial investment includes:
($285,000) delivered cost
($18,000) installation cost
($2,500) removal cost
$4,000 current market value
($1,440) tax on proceeds
2) For year 1 the new system depreciated by 20 percent. Multiply that by the net initial investment and you get the total amount depreciated after 1 year, equal to $60,588. With a 36 percent tax rate you get the depreciated tax savings of $21,812.
Year 2- 32% depreciated
Year 3- 19% depreciated
Year 4- 12% depreciated
Year 5- 11% depreciated
Year 6- 6% depreciated
3) Incremental cash flows: add depreciation tax saving of each year and add after tax cost saving of each year. Year 8 has a cash flow that consist of after tax cost savings and salvage value of the system.
2. What is the project’s NPV? Explain the economic rationale behind the NPV. Could the NPV of this particular project be different for GP Manufacturing than for one of Chino Material Systems Inc.’s other potential customers? Explain.
NPV = $20,578
NPV is a measure of profitability of an investment. If NPV is positive, the company should accept the project. The NPV would be the same for everyone if values were the same because it is just an estimate of future cash flows. The only way it could change is if they used a different cost of capital.
3. Calculate the proposed project’s IRR. Explain the rationale for using the IRR to evaluate capital investment projects. Could the IRR for this project differ for GP Manufacturing versus for another customer?
IRR = 14.32%
The higher the rate, the better. IRR is a good indicator of whether a company should accept a long term investment. Ideally, you want the IRR to be greater than the