financial management

timer Asked: Jun 18th, 2015

Question Description

The firm is considering investing in a capital project; new production line equipment that will have an initial cost of $12 million. The equipment will have a productive life of 5 years, and at the end of this period, it is expected to have a salvage value of $2 million (meaning the firm can sell the used equipment for $2 million). The equipment will be depreciated using the straight-line method for the full 5 years. 

The new production equipment will supplement existing operations. The project is expected to increase revenue for the firm by $10 million per year and increase operating expenses by $6.5 million per year.

First, you need to calculate the annual depreciation on the new equipment; this depreciation figure is needed to calculate the cash flow generated by the project.

Utilize the following table:

Initial Investment

Less Salvage Value

Total Depreciable Value

Life of Project (Years)

Depreciation per Year

Now, you need to calculate the relevant cash flows for the project. You can assume that the firm’s weighted average cost of capital (WACC) is 8%. The firm pays a 29% average tax rate.

Utilize the following table:








Revenue from Project

Operating Expenses

Depreciation (calculated above)

Taxable Income

Less Taxes (29% tax rate)

Net Income

Plus annual Depreciation

Operating Cash Flow

Plus Salvage Value (in year 5)

Relevant Cash Flows (Future Values)

PVIF table factor (i = 10%)

or you may use PV = FV / (1+ i) ^n

Present Value of cash flows (years 1-5)

Total of Present Value of Cash Flows

Initial Investment 

Net Present Value of the Project

Calculate the present values of each relevant cash flow. You may use the PV equation or factors from the PVIF table. Then add them together and subtract the initial investment to calculate the net present value (NPV) of the project.

After completing the required calculations, explain your results in a Word document, and attach your cash flow chart showing your work.

In your analysis of the project, be sure to address the following: 

  • Based on the NPV of this project, would you recommend approving or rejecting the project? 
  • Why would you recommend approval or rejection of the project? Explain. 
  • Describe would happen to the NPV if the WACC increased to 12%? 
  • Explain why the NPV would change the way you described if the firm’s WACC increased. 
  • What is the profitability index of this project, and how does it relate to the NPV? 
  • Using the payback period, how many years would it take for the firm to recover the initial investment even with the understanding this does not take into account the time value of money? 
  • Discuss some of the drawbacks of the payback period.

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