Business Finance

Course Project Part II

Introduction

You will assume that you still work as a financial analyst for AirJet Best Parts, Inc. The company is considering a capital investment in a new machine and you are in charge of making a recommendation on the purchase based on (1) a given rate of return of 15% (Task 4) and (2) the firm’s cost of capital (Task 5).

Task 4. Capital Budgeting for a New Machine

A few months have now passed and AirJet Best Parts, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows:

Year 1 $1,100,000

Year 2 $1,450,000

Year 3 $1,300,000

Year 4 $950,000

You have now been tasked with providing a recommendation for the project based on the results of a Net Present Value Analysis. Assuming that the required rate of return is 15% and the initial cost of the machine is $3,000,000.

1. What is the project’s IRR? (10 pts) 22%

1,100,000/ (1+0.15) ^1 = 1,100,000/1.15 = 956,521.74

1,450,000/ (1+0.15) ^2 = 1,450,000/1.3225 = 1,096,408.32

1,300,000/ (1+0.15) ^3 = 1,300,000/1.52087 = 85, 4771.10

950,000/ (1+0.15) ^4 = 950,000/1.74901 = $543,165.58

2. What is the project’s NPV? (15 pts)

NPV = 956,521.74 + 1,096,408.32 + 854,771.1 + 543,165.58 -3,000,000

NPV = 3,450,866.74 -3,000,000

NPV = $450,866.74

3. Should the company accept this project and why (or why not)? (5 pts)

The company should accept the project because the project has a positive NPV, the IRR is exceeding the company’s needed of rate of return, the annual rate of the project is better than a project that has less return, and the project will be completed in half the time estimated.

4. Explain how depreciation will affect the present value of the project. (10 pts)

Depreciation is a noncash expense accountants compute to show the use of assets by a company. This...