Mitchell Bancorp is considering making a loan at 3% interest (c/a) to SohnCo to
ID: 1194242 • Letter: M
Question
Mitchell Bancorp is considering making a loan at 3% interest (c/a) to SohnCo to buy a machine tool worth $300 million. The tool has no salvage value and is depreciated over 3 years by sum-of-years digits. In this state, SohnCo pays 50% tax. The before-tax cash flow is estimated as $200M, $250M, and $300M over the three years. The CEO of Mitchell Bancorp has noticed that SohnCo has been losing money in this business sector by investing wildly in projects and cautions the use of an After-Tax MARR of at least 12%. Assume that Mitchell Bancorp makes this loan. Will SohnCo generate enough ATCF to pay back this loan???? Explain your answer.Explanation / Answer
ATCF for the first year = $100M
ATCF for the second year = $125M
ATCF for the third year = $150M
First we will discount this cashflows with the MARR of 12%
Present Value of ATCF for the first year = 100 / (1.12) ^ 1 = $89.29M
Present Value of ATCF for the second year = 125 / (1.12) ^ 2 = $99.65M
Present Value of ATCF for the third year = 150 / (1.12) ^ 3 = $103.45M
Present Value of all the cashflows = $292.39M
If the company wants a required rate of return of 12% then it would not be able to pay back the loan.