Introduction
You will assume that you still work as a financial analyst for AirJet Best Parts, Inc. The
company is considering a capital investment in a new machine and you are in charge of
making a recommendation on the purchase based on (1) a given rate of return of 15%
(Task 5) and (2) the firm’s cost of capital (Task 6).
Task 4. Capital Budgeting for a New Machine
A few months have now passed and AirJet Best Parts, Inc. is considering the purchase
on a new machine that will increase the production of a special component significantly.
The anticipated cash flows for the project are as follows:
Year 1
$1,100,000
Year 2
$1,450,000
Year 3
$1,300,000
Year 4
$950,000
You have now been tasked with providing a recommendation for the project based on
the results of a Net Present Value Analysis. Assuming that the required rate of return is
15% and the initial cost of the machine is $3,000,000.
1.
What is the project’s IRR? (10 pts)
Using a financial calculator or a trial and error approach the IRR should be
approximately 22%.
2.
What is the project’s NPV? (15 pts)
($1,100,000/1.15)+($1,450,000/1.15)^2+($1,300,000/1.15)^3+
($950,000/1.15)^4-3,000,000 = $450,867
3.
Should the company accept this project and why (or why not)? (5 pts)
Yes, since NPV>0
4.
Explain how depreciation will affect the present value of the project.
(10 pts)
Answers will vary, students need to recognize depreciation is not a cash
flow, but would affect the tax amount paid on inflows from the project.
5.