The Mulligan company, a manufacturer of electrical parts, is evaluating two mutually exclusive projects A&B. The projects are somewhat riskier than the usual projects the firm undertakes; management uses the subjective approach and decided to apply an adjustment factor of +2% to the cost of capital for both projects.
The company’s a marginal tax rate is 21%, and cost of capital is 11%, evaluate the following proposals.
Project A is a six-year project that requires an initial fixed asset investment of $3 million. The fixed asset falls into the seven-year MACRS class. Based on $20 per unit sale price, the project is estimated to generate $2,050,000 in sales during its first year, with production costs of $950,000. Sales and costs are expected to grow at 3% annually. The project requires a single initial investment in net working capital of $285,000 which is expected to be recovered in six years when the project is terminated. The fixed asset will have a market value of $225,000 at the end of its six years life.
Project B is also a six-year project that requires an initial fixed asset investment of $1.9 million that falls into the seven-year MACRS class. The fixed asset will also require an additional $100,000 in shipping and installation. The marketing firm predicts that first year sales related to the project will be 62,500 units, at a price of $16 per unit, and grow at an annual rate of 4%.
Operating costs related to the project are predicted to be 22% of sales. The project will also require an initial net working capital investment of $150,000 which is expected to be recovered at the end of six years. The asset is expected to have a market value of $22,000 at the end of the six years when the project is terminated.
The MACRS tax rates are given below:
|
Year |
3 |
5 |
7 |
|
1 |
33.33% |
20.00% |
14.29% |
|
2 |
44.44% |
32.00% |
24.49% |
|
3 |
14.81% |
19.20% |
17.49% |
|
4 |
7.41% |
11.52% |
12.49% |
|
5 |
11.52% |
8.92% |
|
|
6 |
5.76% |
8.92% |
|
|
7 |
8.92% |
||
|
8 |
4.46% |
PLEASE SHOW ALL EXCEL FUNCTIONS AND DETAILS.
- Calculate project A’s cash flows for years 0-6
- Calculate NPV, IRR and PI for project A
- Calculate project B’s cash flows for year 0-6
- Calculate NPV, IRR and PI for project B
- Which project should be accepted if any and why?
- What is the exact NPV profile’s crossover rate (incremental IRR)? And what is the relevance of this rate?
