In December of 20X1, Balloon Popper Inc. was trying to decide whether to add a n
ID: 2471811 • Letter: I
Question
In December of 20X1, Balloon Popper Inc. was trying to decide whether to add a new line of super strong balloons to Its product line. In order to do this, it would need to buy a new silkone pouring machine (cost below). Sales for the new balloons were expected to be $2000000 per year from which sales commissions were to be paid to Balloon Poppers sales agents (see below). Direct manufacturing costs were budgeted at $600,000 for materials, and $9000,000 for labor. The new equipment would (cost below) will have a disposal value of $50,000 I have posted the column you should use for your information in Blackboard in Grades, under column. Write the number you are assigned on the top of your solution. From Blackboard Gradebook. Determine if you are using column 1, 2, 3, or 4 Ignoring taxes, what is the IRR of the project? What is the NPV of the new project? Assume the machinery will be installed on January 1 of 20 times 1 and be depreciated using the straight line method, (it is easiest to calculate IRR using Excel) Assuming a 40% tax rate, and that according to the IRS this is a 5 year asset (MACRS rates for Yr 1.2, YR 2.32, YR 3.192, YR 4.115, Y5 5.115, YR 6.058), what is the IRR? What is the NPV? To stimulate industrial development, the tax rules allow 60% of the asset cost to be deducted the first year, with the remaining f the asset cost to be deducted equally over the remaining 4 years (since it is considered to be a 5 year asset). What is the IRR, What is the NPV? If Balloon Popper requires a 12 % return on all new investments, should they take on this investment? What is the payback period? What is the accounting rate of return? Do you believe you should invest in the project? Why? you will be graded 80% on accuracy and 20% on clarity of your findings. If I have to hunt for your answers, or it is not clear how you got your answers, I will take off points.Explanation / Answer
1.
a.
In case of no taxes, depreciation shall be ignored as it is a non cash expense and there will be no tax savings on depreciation.
Annual income from operations = Sales – Material costs – Labor costs – Sales commission = $2,000,000 – $600,000- $900,000 - $200,000 = $300,000
Disposal value at year 5 = $50,000
Initial cost = $1,250,000
At IRR, Initial cost = Present value of future cash flows
$1,250,000 = $300,000/(1+r) + $300,000/(1+r)2 + $300,000/(1+r)3 + $300,000/(1+r)4 + $350,000/(1+r)5
Solving above equation,
R = 0.07458
Hence IRR = 7.46%
b.
Net present value = -Initial cost + Present value of future cash flows = -$1,250,000 + $300,000/1.08 + $300,000/1.082 + $300,000/1.083 + $300,000/1.084 + $350,000/1.085 = -$1,250,000 + $1,231,810 = -$18,190
3.
Year
1
2
3
4
5
Beginning book value of Initial cost
$ 1,250,000.00
$ 1,000,000.00
$ 680,000.00
$ 549,440.00
$ 486,254.40
Depreciation rate
0.2
0.32
0.192
0.115
0.115
Depreciation
$ 250,000.00
$ 320,000.00
$ 130,560.00
$ 63,185.60
$ 55,919.26
Ending book value of initial cost
$ 1,000,000.00
$ 680,000.00
$ 549,440.00
$ 486,254.40
$ 430,335.14
Disposal value
$ 50,000.00
Loss on disposal
-$ 380,335.14
Tax savings on loss on disposal
$ 152,134.06
Net cash flow on disposal
$ 202,134.06
Sales
$ 2,000,000.00
$ 2,000,000.00
$ 2,000,000.00
$ 2,000,000.00
$ 2,000,000.00
Material cost
$ 900,000.00
$ 900,000.00
$ 900,000.00
$ 900,000.00
$ 900,000.00
Labor cost
$ 600,000.00
$ 600,000.00
$ 600,000.00
$ 600,000.00
$ 600,000.00
Sales commission
$ 200,000.00
$ 200,000.00
$ 200,000.00
$ 200,000.00
$ 200,000.00
Net income before tax
$ 300,000.00
$ 300,000.00
$ 300,000.00
$ 300,000.00
$ 300,000.00
Tax @ 40%
$ 120,000.00
$ 120,000.00
$ 120,000.00
$ 120,000.00
$ 120,000.00
Net income after tax
$ 180,000.00
$ 180,000.00
$ 180,000.00
$ 180,000.00
$ 180,000.00
Tax savings on depreciation
$ 100,000.00
$ 128,000.00
$ 52,224.00
$ 25,274.24
$ 22,367.70
Free cash flow
$ 280,000.00
$ 308,000.00
$ 232,224.00
$ 205,274.24
$ 202,367.70
1
280000
0.9259
$ 259,252.00
2
308000
0.8573
$ 264,048.40
3
232224
0.7938
$ 184,339.41
4
205274.2
0.735
$ 150,876.57
5
202367.7
0.6806
$ 137,731.46
5
202134.1
0.6806
$ 137,572.44
Present value of cash flows
$ 1,133,820.28
Less: Initial cost
$ 1,250,000.00
Net Present value
-$ 116,179.72
Year
1
2
3
4
5
Beginning book value of Initial cost
$ 1,250,000.00
$ 1,000,000.00
$ 680,000.00
$ 549,440.00
$ 486,254.40
Depreciation rate
0.2
0.32
0.192
0.115
0.115
Depreciation
$ 250,000.00
$ 320,000.00
$ 130,560.00
$ 63,185.60
$ 55,919.26
Ending book value of initial cost
$ 1,000,000.00
$ 680,000.00
$ 549,440.00
$ 486,254.40
$ 430,335.14
Disposal value
$ 50,000.00
Loss on disposal
-$ 380,335.14
Tax savings on loss on disposal
$ 152,134.06
Net cash flow on disposal
$ 202,134.06
Sales
$ 2,000,000.00
$ 2,000,000.00
$ 2,000,000.00
$ 2,000,000.00
$ 2,000,000.00
Material cost
$ 900,000.00
$ 900,000.00
$ 900,000.00
$ 900,000.00
$ 900,000.00
Labor cost
$ 600,000.00
$ 600,000.00
$ 600,000.00
$ 600,000.00
$ 600,000.00
Sales commission
$ 200,000.00
$ 200,000.00
$ 200,000.00
$ 200,000.00
$ 200,000.00
Net income before tax
$ 300,000.00
$ 300,000.00
$ 300,000.00
$ 300,000.00
$ 300,000.00
Tax @ 40%
$ 120,000.00
$ 120,000.00
$ 120,000.00
$ 120,000.00
$ 120,000.00
Net income after tax
$ 180,000.00
$ 180,000.00
$ 180,000.00
$ 180,000.00
$ 180,000.00
Tax savings on depreciation
$ 100,000.00
$ 128,000.00
$ 52,224.00
$ 25,274.24
$ 22,367.70
Free cash flow
$ 280,000.00
$ 308,000.00
$ 232,224.00
$ 205,274.24
$ 202,367.70