Question And Problem Sets: Calculating IRR For A Firm

Question And Problem Sets Iiich 97calculating Irr Lo5a Firm Eva

Question and Problem Sets III Ch. . Calculating IRR [LO5] A firm evaluates all of its projects by applying the IRR rule. If the required return is 14 percent, should the firm accept the following project? 8. Calculating NPV [LO1] For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a required return of 11 percent, should the firm accept this project? What if the required return is 24 percent? Ch. 10 3. Calculating Projected Net Income [LO1] A proposed new investment has projected sales of $635,000. Variable costs are 44 percent of sales, and fixed costs are $193,000; depreciation is $54,000. Prepare a pro forma income statement assuming a tax rate of 35 percent. What is the projected net income? 13. Project Evaluation [LO1] Dog Up! Franks is looking at a new sausage system with an installed cost of $540,000. This cost will be depreciated straight-line to zero over the project’s five-year life, at the end of which the sausage system can be scrapped for $80,000. The sausage system will save the firm $170,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $29,000. If the tax rate is 34 percent and the discount rate is 10 percent, what is the NPV of this project? Ch. 11 1. Calculating Costs and Break-Even [LO3] Night Shades, Inc. (NSI), manufactures biotech sunglasses. The variable materials cost is $9.64 per unit, and the variable labor cost is $8.63 per unit. a. What is the variable cost per unit? b. Suppose NSI incurs fixed costs of $915,000 during a year in which total production is 215,000 units. What are the total costs for the year? c. If the selling price is $39.99 per unit, does NSI break even on a cash basis? If depreciation is $465,000 per year, what is the accounting break-even point? 7. Calculating Break-Even [LO3] In each of the following cases, calculate the accounting break-even and the cash break-even points. Ignore any tax effects in calculating the cash break-even.

Paper For Above instruction

The evaluation of investment projects and financial decision-making require a comprehensive understanding of various financial metrics, including the Internal Rate of Return (IRR), Net Present Value (NPV), projected net income, and break-even analysis. This paper discusses the application of these financial tools in practical scenarios, illustrating their importance in capital budgeting and strategic planning.

Introduction

Financial decision-making forms the backbone of corporate strategy, guiding firms in selecting projects that maximize value and ensure sustainable growth. Key metrics like IRR and NPV are critical in assessing the feasibility of investment opportunities. Additionally, understanding projected net income aids in forecasting profitability, while break-even analysis helps determine the minimum operational levels necessary for viability.

Calculating IRR and NPV

The IRR is the discount rate at which the present value of cash inflows equals the initial investment, essentially indicating the project’s rate of return. When evaluating a project with a required return of 14%, a firm must determine if the calculated IRR exceeds this threshold for acceptance. For example, if the IRR calculated from the project’s cash flows is 16%, it would be accepted; if it’s 12%, it would be rejected. Conversely, NPV measures the absolute value added by a project by discounting cash flows at the firm's cost of capital. Using the same cash flows, if the NPV is positive at an 11% discount rate, the project is acceptable; if negative at 24%, it should be rejected. These metrics provide complementary insights into project profitability and risk.

Projected Net Income

Accurate forecasting of net income is essential for evaluating a project's profitability. Considering a proposed investment with sales of $635,000, variable costs at 44%, fixed costs at $193,000, and depreciation of $54,000, the calculation begins by determining the contribution margin:

Variable costs = $635,000 × 44% = $279,400

Contribution margin = $635,000 - $279,400 = $355,600

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) = $355,600 - $193,000 = $162,600

Tax expense = $162,600 × 35% = $56,910

Net income = ($162,600 - $54,000) - $56,910 = $51,690

Thus, the projected net income stands at approximately $51,690, providing crucial insight into profitability post-tax.

Project Evaluation and NPV Calculation

Evaluating a new sausage system involves calculating the NPV by considering initial costs, salvage value, operational savings, and changes in net working capital. The initial investment includes the cost of the system ($540,000) and the net working capital ($29,000). Depreciation is straight-line over five years, yielding an annual expense of $108,000. The project generates annual pretax savings of $170,000, which after a 34% tax rate results in residual after-tax benefits.

Annual savings after taxes = $170,000 × (1 - 0.34) = $112,200

The after-tax salvage value, considering depreciation recapture, is also included in the cash flows at the end of five years. The NPV is then computed by discounting these cash flows at 10%, summing the present value of annual savings, adding the present value of salvage value, and subtracting initial investments. If the resulting NPV exceeds zero, the project is deemed financially viable.

Break-Even and Cost Calculations

For Night Shades, Inc., the variable cost per unit combines costs of materials ($9.64) and labor ($8.63), totaling $18.27 per unit. Fixed costs are $915,000 annually, and total production is 215,000 units. Total costs are then:

Total variable costs = $18.27 × 215,000 = $3,932,550

Total costs = Fixed costs + Variable costs = $915,000 + $3,932,550 = $4,847,550

Break-even analysis considers both cash and accounting perspectives. The cash break-even point ignores depreciation, focusing solely on covering variable and fixed costs with sales revenue. The accounting break-even includes depreciation, reflecting total expenses. If the selling price per unit is $39.99, then:

Contribution margin per unit = $39.99 - $18.27 = $21.72

Cash break-even volume = Fixed costs / Contribution margin per unit = $915,000 / $21.72 ≈ 42,130 units

Accounting break-even volume = (Fixed costs + Depreciation) / Contribution margin per unit = ($915,000 + $465,000) / $21.72 ≈ 63,276 units

This analysis guides NSI in setting sales targets to ensure profitability.

Conclusion

Financial evaluation tools such as IRR, NPV, projected net income analysis, and break-even points are vital for effective investment decision-making. They enable firms to quantify potential gains, assess risks, and determine operational thresholds. Proper application of these metrics leads to strategic investments aligned with the firm’s financial goals and market conditions.

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