Figure 4 Financial analysis of Project D: Add fleet of trucks Initial Expenditures Year 1 Year...
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Figure 4 Financial analysis of Project D: Add fleet of trucks Initial Expenditures Year 1 Year 2 Year 3 Year 4 Year 5 Net cost of new trucks Additional revenue Additional operating costs Depreciation Net increase in income.... Less: Tax at 33% $510,000 $382,500 $325,125 $ 89,250 $ 76,500 $ 51,000 19,125 19,125 25,500 76,500 112,200 107,100 31,875 107,100 286,875 193,800 (43,350) (62,475) 94,669 Increase in after-tax income..... 63,954 0 0 $192,206 $129,846 ($ 43,350) ($ 62,475) 38,250 107.100 (94,350) 0 $ 94,350) Add back depreciation. Net change in cash flow........... $ 76,500 ($510,000) 268,706 $112,200 242,046 $107,100 63,750 107,100 $107,100 44,625 12,750 REQUIRED: 1. 2. Refer to Figures 1 through 4. Add up the total increase in after-tax income for each project. Given what you know about Marsha Kay, to which project do you think she will be attracted? Compute the payback period, internal rate of return (IRR), and net present value (NPV) of all four alternatives based on cash flow. Use 10 percent for the cost of capital in your calculations. For the payback method, merely indicate the year in which the cash flow equals or exceeds the initial investment. You do not have to compute mid-year points. According to the payback method, which project should be selected? 3. a. b. What is the chief disadvantage of this method? C. Why would anyone want to use this method? According to the IRR method, which project should be chosen? a. 4. b. C. What is the major disadvantage of the IRR method that occurs when high IRR projects are selected? Can you think of another disadvantage of the IRR method? (Hint: Look over the four alternatives and compare the sizes of the projects. Ask yourself whether you would prefer to make a large percent return on a small amount of money or a small percent gain on a large amount of money.) d. If Marsha had not put a limit on the size of the capital budget, would the IRR method allow acceptance of all four alternatives? If not, which one(s) would be rejected and why? a. According to the NPV method, which project should be chosen? How does this differ from the answer under the IRR? b. If Marsha had not put a limit on the size of the capital budget, under the NPV method which projects would be accepted? Do the NPV and IRR both reject the same project(s)? Why? C. Given all the facts of the case, are you more likely to select Project A or C? Figure 4 Financial analysis of Project D: Add fleet of trucks Initial Expenditures Year 1 Year 2 Year 3 Year 4 Year 5 Net cost of new trucks Additional revenue Additional operating costs Depreciation Net increase in income.... Less: Tax at 33% $510,000 $382,500 $325,125 $ 89,250 $ 76,500 $ 51,000 19,125 19,125 25,500 76,500 112,200 107,100 31,875 107,100 286,875 193,800 (43,350) (62,475) 94,669 Increase in after-tax income..... 63,954 0 0 $192,206 $129,846 ($ 43,350) ($ 62,475) 38,250 107.100 (94,350) 0 $ 94,350) Add back depreciation. Net change in cash flow........... $ 76,500 ($510,000) 268,706 $112,200 242,046 $107,100 63,750 107,100 $107,100 44,625 12,750 REQUIRED: 1. 2. Refer to Figures 1 through 4. Add up the total increase in after-tax income for each project. Given what you know about Marsha Kay, to which project do you think she will be attracted? Compute the payback period, internal rate of return (IRR), and net present value (NPV) of all four alternatives based on cash flow. Use 10 percent for the cost of capital in your calculations. For the payback method, merely indicate the year in which the cash flow equals or exceeds the initial investment. You do not have to compute mid-year points. According to the payback method, which project should be selected? 3. a. b. What is the chief disadvantage of this method? C. Why would anyone want to use this method? According to the IRR method, which project should be chosen? a. 4. b. C. What is the major disadvantage of the IRR method that occurs when high IRR projects are selected? Can you think of another disadvantage of the IRR method? (Hint: Look over the four alternatives and compare the sizes of the projects. Ask yourself whether you would prefer to make a large percent return on a small amount of money or a small percent gain on a large amount of money.) d. If Marsha had not put a limit on the size of the capital budget, would the IRR method allow acceptance of all four alternatives? If not, which one(s) would be rejected and why? a. According to the NPV method, which project should be chosen? How does this differ from the answer under the IRR? b. If Marsha had not put a limit on the size of the capital budget, under the NPV method which projects would be accepted? Do the NPV and IRR both reject the same project(s)? Why? C. Given all the facts of the case, are you more likely to select Project A or C?
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