The Shome Corporation, a firm in the 21 percent marginal tax bracket with a 15 percent required
Question:
The Shome Corporation, a firm in the 21 percent marginal tax bracket with a 15 percent required rate of return or cost of capital, is considering a new project. The project involves the introduction of a new product. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. Given the following information, determine the free cash flows associated with the project, the project’s net present value, the profitability index, and the internal rate of return. Apply the appropriate decision criteria.
Cost of new production equipment $6,900,000 Shipping and installation costs $ 100,000 UNIT SALES YEAR UNITS SOLD 80,000 2 100,000 3 120,000 4 70,000 70,000 Sales price per unit $250/unit in years 1 through 4, $200/unit in year 5 Variable cost per unit $130/unit Annual fixed costs $300,000 per year in years 1–5 There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in working capi- tal will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5. Working-capital requirements Depreciation method Bonus depreciation method, and as a result the bonus deprecia- tion occurs in year 1, with no depreciation in any other years. If any losses occur, they would be offset by profits in other areas of the company.
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Section I Calculate the change in EBIT taxes and depreciation This becomes an input in the calculati...View the full answer
Foundations Of Finance
ISBN: 9780135160619
10th Edition
Authors: Arthur J. Keown, John H. Martin, J. William Petty
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Internal rate of return is a method of calculating an investment’s rate of return. The term internal refers to the fact that the calculation excludes external factors, such as the risk-free rate, inflation, the cost of capital, or financial risk.
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