Year 0 1 2 3 4 5
Accounts Receivable $0 $100,000 $150,000 $200,000 $100,000 $0
Inventory $0 $300,000 $350,000 $400,000 $200,000 $0
The firm faces a tax rate of 34%.
a. Calculate the project’s cash flows each year.
b. Calculate the NPV assuming a 10% opportunity cost of capital. What is the cost of capital is 15%?
c. What is the IRR of the investment?
2. A bicycle manufacturer currently produces 300,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $2 a chain. The plant manager believes that it would be cheaper to make these chains rather than buy them. Direct in-house production costs are estimated to be only $1.50 per chain. The necessary machinery would cost $250,000 and would be obsolete after 10 years. This investment could be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule. Expected proceeds from scrapping the machinery after 10 years are $20,000. The plant manager estimates that the operation would require additional working capital of $50,000 at the outset of the project but argues that this sum can be ignored since it will be recoverable at the end of 10 years. If the company pays tax at a rate of 35% and the opportunity cost of capital is 15%, what is the net present value of the decision to produce the chains in-house instead of purchasing them from the supplier?
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