Ch 9 Questions 7 8 And Problems Section 7 Calculat

Ch 9 Questions 7 8 Questions And Problems Section7calculat

Calculate the internal rate of return (IRR) for a project when the required return is 14% to determine if the firm should accept the project. Also, evaluate the project's net present value (NPV) at different required returns of 11% and 24% using the cash flows from the previous problem to decide whether to accept it.

Next, prepare a pro forma income statement for a proposed new investment with projected sales of $635,000. Variable costs are 44% of sales, fixed costs are $193,000, and depreciation is $54,000. Calculate the projected net income assuming a tax rate of 35%.

Additionally, analyze a project involving a sausage system with an initial cost of $540,000 depreciated straight-line over five years, resulting in a salvage value of $80,000. The project is expected to save $170,000 annually in pretax operating costs, requiring an initial net working capital investment of $29,000, with a tax rate of 34% and a discount rate of 10%. Determine the net present value (NPV) of this project.

Finally, analyze the costs and break-even points for Night Shades, Inc. (NSI), which manufactures biotech sunglasses. The variable costs per unit are $9.64 (materials) and $8.63 (labor). Calculate the variable cost per unit, total costs for the year if production is 215,000 units with fixed costs of $915,000, and evaluate whether NSI breaks even on a cash basis with a selling price of $39.99 per unit. Also, find the accounting break-even point considering an annual depreciation expense of $465,000.

Paper For Above instruction

Financial decision-making within a firm relies heavily on evaluating potential projects through various metrics such as the Internal Rate of Return (IRR), Net Present Value (NPV), and understanding cost behavior and break-even analysis. These tools facilitate informed choices that align with the company's strategic goals and financial health.

Calculating IRR and NPV for Investment Projects

The IRR is a critical metric in capital budgeting, indicating the discount rate at which the present value of cash inflows equals the initial investment. When a firm evaluates projects based solely on the IRR rule, a project is typically accepted if its IRR exceeds the required return. In this context, with a required return of 14%, the firm must compute the project's IRR based on its cash flows. If the IRR surpasses 14%, the project adds value and should be considered. Conversely, if the IRR is below this threshold, it might be rejected.

Complementary to IRR, NPV measures the absolute value added to the firm by the project, discounting future cash flows at the firm’s required rate of return. When evaluating with an 11% discount rate, if the NPV is positive, the investment is considered profitable; if negative, it should be rejected. At a 24% discount rate, a negative NPV indicates the project may not generate sufficient returns to meet the higher hurdle rate. These evaluations help in understanding how sensitive a project’s viability is to changes in the discount rate and assist in making well-rounded decisions.

Preparing a Pro Forma Income Statement

The analysis of the proposed investment begins with estimating the revenues and costs. With projected sales of $635,000 and variable costs constituting 44% of sales, the variable costs amount to $279,400 (0.44 × 635,000). Fixed costs are given as $193,000, and depreciation is $54,000. To compute the pre-tax income:

  • Sales: $635,000
  • Variable costs: $279,400
  • Contribution margin: $355,600
  • Fixed costs: $193,000
  • EBITDA: $162,600
  • Depreciation: $54,000
  • EBIT: $108,600

Calculating taxes at 35% on EBIT ($108,600) results in tax payments of approximately $37,005. The net income after taxes is approximately $71,595, which provides a key indicator of profitability for the project.

Evaluating Project Investment with NPV

The sausage system project involves an initial investment of $540,000, which will be straight-line depreciated over five years to a salvage value of $80,000. This depreciation results in annual depreciation expenses of $108,000 ($540,000 / 5). The project saves $170,000 annually in pretax operating costs, which enhances cash flows. An initial net working capital investment of $29,000 is required, and at the end of five years, both the project’s salvage value and recovered working capital affect the net cash flows.

To calculate the NPV, the after-tax savings are considered. Pretax savings of $170,000, when taxed at 34%, lead to after-tax savings of approximately $112,200 ($170,000 × (1 - 0.34)). The depreciation shield also impacts cash flows by reducing taxable income. The salvage value of $80,000, taxed at the appropriate rate considering the book value, and recovery of the net working capital are included in the terminal cash flow.

Using a discount rate of 10%, the present value of annual savings and terminal cash flows results in an NPV that indicates whether the project adds value. A positive NPV suggests acceptance, while a negative value would caution against proceeding.

Cost and Break-Even Analysis for NSI

Night Shades, Inc. faces variable costs of $9.64 for materials and $8.63 for labor per unit, leading to a total variable cost of $18.27 per unit. This variable expense impacts profit margins and pricing strategies. Fixed costs of $915,000 annually and production of 215,000 units determine the total costs for the year. The total variable costs amount to approximately $3,927,450 ($18.27 × 215,000), which combined with fixed costs results in total costs of $4,842,450. This information helps assess the company's profitability and cost structure.

To determine if NSI is breaking even on a cash basis, the company compares total revenue to total variable plus fixed costs. With a selling price of $39.99 per unit, total sales revenue is approximately $8,598,850. Since this exceeds total costs, NSI is covering its fixed and variable expenses on a cash basis.

Considering depreciation expenses of $465,000 per year, the accounting break-even point is where total revenue equals fixed costs plus depreciation expenses. This involves calculating the required sales volume to cover all costs, including non-cash depreciation, ensuring profitability on an accounting basis.

Overall, these financial analyses assist managers in making data-driven decisions, optimizing investment appraisals, cost management, and pricing strategies, ultimately enhancing the firm’s value and operational efficiency.

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