Problem 11-12

New Project Analysis

Madison Manufaruring is considering a new machine that costs $350,000 and would reduce pre-tax manufacturing costs by $110,000 annually. Madison would use the 3-year MACRS method to depriciate the machine and management thinks the machine would have a value of $33,000 at the end of its 5-year operating life. The applicable depriciation rates are 33.33%, 44.45%, 14.81% and 7.42% as discussed in Appendix 11A. Working capital would increase by $35,000 initially but it would be recovered at the end of the project's 5 year life. Madison marginal tax rate is 40% and a 10% WACC is appropriate for this project.

a. calculate the projects NPV, IRR, MIRR and payback

b. Assume management is unsure about the $110,000 cost savings--this figure could deviate by as much as plus or minus 20%. What would the NPV be under each of these extremes?

c. Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine's salvage value and the working capital (WC) requirement. She asks you to use the following probablities and values in the scenario analysis.

Scenario Probability Cost Savings Salvage Value WC

Worst Case 0.35 $88,000 $28,000 $40,000

Base Case 0.35 110,000 $33,000 35,000

Best Case 0.30 132,000 38,000 30,000

Calculate the projects expected NPV, its standard deviation and its coefficient of variation. Would you recommend that the project be accepted?

Answer is:

a. NPV = $15,732

IRR = 11.64%

MIRR = 10.88% Payback = 3.75 years

b. $65,770; -$34,307

c. E(NPV) = $13,041

oNPV = $43,289

CV = 3.32

Show all work and formulas to support answers!!