Question 16 Nyke Inc. is a Sporting Shoes Company which is considering investing
ID: 2789749 • Letter: Q
Question
Question 16
Nyke Inc. is a Sporting Shoes Company which is considering investing in a new equipment for the production of a new line of Tennis and Football Shoes for its elite customers. The new equipment will costs $250,000, and an additional $80,000 is needed for installation. The equipment which falls into the MACRS 3-yr class, would be sold after three years for $35,000.
The equipment will generate additional annual revenues of $210,000, and will have annual operating expenses of $60,000. An inventory investment of $60,000 is required during the life of the project. Nyke is in the 30 percent tax bracket, and has the same risk as the firm’s existing assets. Its existing cost of capital is 15 percent.
Required:
Calculate the initial outlay of the project.
Calculate the annual after-tax operating cash flow for Years 1 -3.
Determine the terminal year (in year 3) after-tax non-operating cash flow.
What is the project NPV?
What is the estimated Internal Rate of Return (IRR) of the project? Should the project be accepted based on the IRR criterion? Why?
Explanation / Answer
a) Cost of new Equipment $250,000 Add Installtion $80,000 Add Change in working Capital $60,000 Initial Outlay of the project $390,000 b) Year 1 2 3 Annual Revenue $210,000 $210,000 $210,000 Less: Operating Expenses -60000 -60000 -60000 Less: Depreciation = $330,000 x Depreciation Rate MACRS 3 year (33.33%,44.45%,14.81% -$109,989 -$146,685 -$48,873 Net operating Income $40,011 $3,315 $101,127 Less: Tax @ 30% -$12,003.3 -$994.5 -$30,338.1 Net income $28,007.7 $2,320.5 $70,788.9 Add: Depreciation $109,989 $146,685 $48,873 Annual after-tax operating cash flow $137,996.7 $149,005.5 $119,661.9 c) Salvage Value $35,000 Book Value of Equipment = $330,000 x (1-33.33% +44.45%+14.81%) $24,453 Gain on sale $10,547 Tax shield on Gain ($10547 x 30%) $3,164.1 TNOCF = Sal3 + NWCInv - T(Sl 3 - B3) Terminal value in year 3 Net working Capital $60,000 Salvage Value $35,000 less: Tax shield on Gain -$3,164.1 After-tax non-operating cash flow $91,835.9 d Year Cash Flow PV @15% Present Value 0 -$390,000 1 -$390,000 1 $137,996.7 0.869565217 $119,997.13 2 $149,005.5 0.756143667 $112,669.57 3 $211,497.8 0.657516232 $139,063.24 NPV -$18,270.07 IRR 12.35% The project should not be accepted as IRR (12.35%)is less than cost of capital(15%) year 3 cash flow = annual operating cash flow + terminal value