Question

May&Co is considering the purchase of a new plywood machine . The machine will cost $ 1.4 million . It will generate a net after - tax cash flow of 350.000 $ per year for six years . May&Co cost of capital is 14 % . ( Show your work )

a . What is the NPV of this project ?
b . What is the IRR of this project ?
c. Is this project acceptable if May&Co uses the payback method with a 4 - year payback requirement ?
d . If May&Co uses discounted payback with a 5 - years requirement , is this project acceptable ?
e . Based on your answers above , is this a good project ?

Answer 1

To evaluate May&Co's project, we calculate the NPV by discounting the after-tax cash flows and subtracting the cost of investment. The IRR is determined to find the discount rate that makes the NPV zero. Additionally, we examine if the payback and discounted payback requirements are met to assess the project's acceptability.

Step-by-step explanation:

Net Present Value (NPV) and Internal Rate of Return (IRR) Calculations

To calculate the NPV of May&Co's potential investment in a new plywood machine, we need to discount the projected after-tax cash flows back to their present value and subtract the initial investment. The formula for NPV is:

NPV = ∑ (Cash Flow at Time t / (1 + r)^t) - Cost of Investment

Where:

• Cash Flow at Time t is $350,000 for each of the six years.
• r is the cost of capital of 14% (0.14).
• t is the year for which the cash flow is being calculated.
• Cost of Investment is $1.4 million.

Calculating NPV step by step:

1. Find the present value of the cash flows for each year.
2. Sum the present values.
3. Subtract the initial investment from the sum of present values.

The IRR is the discount rate that makes the NPV of the project equal to zero. It's found by iteration or using financial calculators or software.

For the payback method, the project is acceptable if the initial investment is fully recovered within the payback period. May&Co requires a 4-year payback, so we sum the annual cash flows to verify if by year 4 the $1.4 million is recovered:

1. Add the yearly cash flows and check if they equal or exceed the initial investment by the fourth year.

For the discounted payback method, it's similar to the payback method but the cash flows are discounted to their present value. If the sum of discounted cash flows recovers the initial investment by the fifth year, then the project is acceptable.

Based on the NPV, IRR, payback period, and discounted payback calculations, we can determine the project's viability.