II. Lugar Industries is considering an investment in a proposed project which re
ID: 2802414 • Letter: I
Question
II. Lugar Industries is considering an investment in a proposed project which requires an initial expenditure of $100,000 at t 0. This expenditure can be depreciated at the following annual rat Year Depreciation Rate 20% 32 19 e project has an economic life of six years. The project's revenues are forecasted to be $90,000 a yea years.theotng costs (not including depreciation) are forecasted to be $50,000 a year. After si The project's operati The e project's estimated salvage value is $10,000. There is no additional working capital e company's WACC is 10 percent, and its corporate tax rate is 40 percent. What are t t present value (NPV) and internal rate of return (IRR)? Should Lugar undertake this proj requirement. Th project's ne (20 points)Explanation / Answer
Answer: Formulas used in the calculation are
Depreciation : (Book value - salvage value ) * depreciation rate given in the table
Cash flow on which tax will be applied = revenue - expenses - depreciation
Net cash flow = revenue - expenses - tax + salvage value
present value = cash flow / ( 1 + interest rate) ^ ( no of years)
NPV sum of all present values
IRR rate at which NPV becomes zero
they should take this project as both NPV being positive and IRR being higher indicates
0 1 2 3 4 5 6 Investment 100000 Revenue 90000 90000 90000 90000 90000 90000 Expenditure 50000 50000 50000 50000 50000 50000 Dep 18000 28800 17100 10800 9900 5400 Salvage value 10000 Cash flow for tax -100000 22000 11200 22900 29200 30100 44600 tax 0 8800 4480 9160 11680 12040 17840 net cash flow (adding back depreciation) -100000 31200 35520 30840 28320 27960 32160 present value -100000 28363.64 29355.37 23170.55 19342.94 17360.96 18153.48 NPV 35746.93956 IRR 11%