Introduction

You will assume that you still work as a financial analyst for AirJet Best Parts, Inc. The company is considering a capital investment in a new machine and you are in charge of making a recommendation on the purchase based on (1) a given rate of return of 15% (Task 4) and (2) the firm’s cost of capital (Task 5).

Task 4. Capital Budgeting for a New Machine

A few months have now passed and AirJet Best Parts, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows:

Year 1 $1,100,000

Year 2 $1,450,000

Year 3 $1,300,000

Year 4 $950,000

You have now been tasked with providing a recommendation for the project based on the results of a Net Present Value Analysis. Assuming that the required rate of return is 15% and the initial cost of the machine is $3,000,000. 1. What is the project’s IRR? (10 pts)

Answer:

Irr=iL+[(iU-iL)(npvL)]/[npvL-npvU]

Irr=0.19+[(0.24-0.19)(193484.61)]/[193484.61-86216.77]

Irr=0.19+[(0.05)(193484.61)]/[279701.38]

Irr=0.19+9674.2305/279701.38

Irr=0.19+0.0346

Irr=0.22446 or 22.46% 2. What is the project’s NPV? (15 pts)

Answer:

1,100,000/(1+0.15)^1=1,100,000/1.15=$956,521.74

1,450,000/(1+0.15)^2=1,450,000/1.3225=$1,096,408.32

1,300,000/(1+0.15)^3=1,300,000/1.52087=$854,771.10

950,000/(1+0.15)^4=950,000/1.74901=$543,165.58

$956,521.74+1,096,408.32+854,771.10+543,165.58=$3,450,866.74

$3,450,866.74-3,000,000=$450,866.74

NPV=$450,866.74

3. Should the company accept this project and why (or why not)? (5 pts)

Answer: Yes, I believe the company should accept this project. The company’s IRR is greater than the RRR and the NPV of $450,866.74 is a positive. Whenever the Irr is greater than the RRR or the NPV is zero or greater, the investment will earn a return greater than the RRR.

4. Explain how depreciation will affect the present value of