CoolTech Inc. is considering a new refrigerated warehouse which will cost $7,000
ID: 2768778 • Letter: C
Question
CoolTech Inc. is considering a new refrigerated warehouse which will cost $7,000,000 and is expected to have revenues of $900,000 at the end of each of the next 5 years and expenses of $200,000 for years 1-3 and $250,000 for years 4-5. The warehouse is depreciated for 40 years on a straight line basis and expects to have a salvage value of $1,000,000. At the end of 5 years, they expect to sell the warehouse for $6,000,000. Working capital requirements will be $125,000 up front. CoolTech’s tax rate is 40% and their cost of capital is 12%. CoolTech’s IRR is __________%
Explanation / Answer
Year 1 2 3 4 5 Annual Sales a $900,000.00 $900,000.00 $900,000.00 $900,000.00 $900,000.00 Costs b $200,000.00 $200,000.00 $200,000.00 $250,000.00 $250,000.00 Depreciation per year ($7m - $1m) / 40 years c $150,000.00 $150,000.00 $150,000.00 $150,000.00 $150,000.00 Earnings before Tax d = a-b-c $550,000.00 $550,000.00 $550,000.00 $500,000.00 $500,000.00 Taxes at 40% e = d*40% $220,000.00 $220,000.00 $220,000.00 $200,000.00 $200,000.00 Earnings after Tax f = d - e $330,000.00 $330,000.00 $330,000.00 $300,000.00 $300,000.00 Depreciation g $150,000.00 $150,000.00 $150,000.00 $150,000.00 $150,000.00 Cashflow from operations h = f+g $480,000.00 $480,000.00 $480,000.00 $450,000.00 $450,000.00 Working Capital Realization i $0.00 $0.00 $0.00 $0.00 $125,000.00 Post tax salvage value of Machine j $0.00 $0.00 $0.00 $0.00 $6,100,000.00 Net Cashflows k = h+i+j $480,000.00 $480,000.00 $480,000.00 $450,000.00 $6,675,000.00 PV Factor at 4% l 0.9615 0.9246 0.8890 0.8548 0.8219 Present Value at 4% m = k*l $461,538.46 $443,786.98 $426,718.25 $384,661.89 $5,486,363.44 PV of Inflow at 4% $7,203,069.02 PV Factor at 5% n 0.9524 0.9070 0.8638 0.8227 0.7835 Present Value at 5% o = k*n $457,142.86 $435,374.15 $414,642.05 $370,216.11 $5,230,037.16 PV of Inflow at 5% $6,907,412.33 Initial Outflow Machine Cost $7,000,000.00 Working Capital $125,000.00 $7,125,000.00 At IRR, PV of Inflow = PV of Outflow IRR = 4% + (7125000 - 7203069.02) / (6907412.33 - 7203069.02) = 4% + (78069.02 / 295656.69) = 4% + 0.26% = 4.26% Note 1 Purchase Cost of Machine $7,000,000.00 Less: Accumulated Depreciation $750,000.00 Book Value (a) $6,250,000.00 Market Value of Machine (b) $6,000,000.00 Profit on Sale on Machine (c = b-a) -$250,000.00 Tax Shield on Loss (d = c*40%) -$100,000.00 Post Tax Salvage Value (b-d) $6,100,000.00