Finance 520

Chicago Valve Company

1) For year “0” the only input is the initial standard petroleum valve system cost of $212,500 ($200,000 for the petroleum valve system and $12,500 to install the equipment). The inputs for year “2” consist of a specific depreciation tax savings of 32% times the federal-plus-state tax rate of 40%. When doing the arithmetic, the total depreciation tax savings for year “2” is $17,000 ($212,500 * .32 = $68,000, $68,000 * .40 = $27,200). Therefore, the remaining of four years of depreciation allowances undergoes a different rate of which its final answer will be calculated with the federal-plus-state rate of 40%. The depreciation rates are as follows: Yr3 = 19%, Yr4 = 12%, Yr5 = 11%, and Yr6 = 6%. The net cash flow is determined by Lone Star after deducting cash outflows from cash inflows. This is the reason why the net cash flows are different each year on Table 1. The Cash flows continually decrease because there are less cash inflows, no depreciation, depletion or amortization.

2) The NPV is $36,955.10 (NPV= (11, -212,500, L1). The NPV of this particular project can be different for Lone Star Petroleum Company than for one of Chicago Valve’s other potential customers. Each customer has a different cost of capital percentage used when budgeting. In addition, that different customer might have a straight line depreciation tax savings compared to Lone Star, who has specific depreciation allowance percentages to discount each year. Also, the customers NPV might be higher if that other customer has more cash inflows, which will increase the company net cash flow. As for Lone Star, they have a decreasing net cash flow.

3) The proposed IRR is 16.20% (IRR= (-212,500, L1). The purpose of the IRR is to analyze future or current project investments. It calculates the rate of return that’s equivalent to the present value of the projected forthcoming cash outflows and inflows of a specific investment. The IRR can differ for Lone Star versus...