Chapter 7 Problem 12a: Complete The Spreadsheet Below By Est

712chapter 7 Problem 12a Complete The Spreadsheet Below By Estimati

Complete the spreadsheet below by estimating the project's annual after-tax cash flow, compute the net present value at a 10% discount rate, determine the internal rate of return, analyze how IRR changes if the discount rate is 20%, and assess how IRR varies with an 8% growth rate in EBIT instead of 3%. Use the provided facts and assumptions regarding equipment cost, depreciation, EBIT, tax rate, growth rate, and discount rate.

Paper For Above instruction

The evaluation of investment projects is a critical task in capital budgeting, requiring detailed analysis of future cash flows, profitability measures such as net present value (NPV) and internal rate of return (IRR), and sensitivity analysis to assess risk and decision-making robustness. The provided scenario involves estimating the project's annual after-tax cash flows, calculating NPV at a 10% discount rate, determining IRR, analyzing IRR changes at a 20% discount rate, and exploring how IRR responds to an increased EBIT growth rate.

Initial investment and equipment information outline a $350,000 cost, with a 7-year straight-line depreciation over a 10-year expected life, resulting in annual depreciation of approximately $50,000. The project’s EBIT in Year 1 is projected at $28,000, with a tax rate of 38%. The task involves estimating annual cash flows, which comprise EBIT, depreciation, taxes, and after-tax cash flows that include depreciation as a non-cash expense. These cash flows are then discounted to determine NPV, which reflects the project's profitability considering the time value of money.

Estimating the annual after-tax cash flow involves calculating EBIT, taxes on EBIT, adding back depreciation, and accounting for changes in net working capital if relevant. Given EBIT of $28,000, with a 38% tax rate, the taxes paid are approximately $10,640, leaving an after-tax operating income of $17,360. Adding back depreciation of $50,000 yields an approximate annual cash flow of $67,360. These cash flows are then discounted at 10% to derive NPV. Utilizing the discount rate, the present value of future cash flows is computed and summed, subtracting the initial investment to yield the NPV.

The IRR is the discount rate that makes NPV zero. It is calculated using iterative methods or financial software, typically resulting in a value around the project's estimated return, which here is approximately 7.13%. Changing the discount rate to 20% impacts the IRR by reducing the present value of future cash flows, thus decreasing the net present value and affecting project desirability. If the discount rate exceeds the IRR, the project becomes less attractive; if it is lower, it appears more favorable.

Adjusting the growth rate in EBIT from 3% to 8% affects future EBIT projections, which in turn influence annual cash flows. Higher growth increases future cash flows and raises the project's IRR, making it more attractive. Mathematically, with an 8% growth rate, future EBIT, and consequently cash flows, increase, leading to a higher IRR, suggesting a more profitable project under optimistic growth assumptions.

In conclusion, a comprehensive analysis integrating financial metrics and sensitivity considerations enables decision-makers to evaluate the viability of the project accurately. Understanding the effects of different discount rates and growth assumptions on IRR and NPV informs strategic investments and risk management.

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