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 4) and (2) the firm’s cost of capital (Task 5).
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)
The internal rate of return is 22.4% for this project.
2.
What is the project’s NPV? (15 pts)
The net present value of the project is $450,866.9.
3.
Should the company accept this project and why (or why not)? (5 pts)
I do think the company should accept this project, because when NPV of a prospective
project is positive, it should be accepted. If NPV is negative, the project should probably
be rejected because cash flows will also be negative. Therefore since the NPV is
459,866.9, which is positive, also it is a very good amount of comparison to the value of
a dollar today to the value of that same dollar in the future.
4.
Explain how depreciation will affect the present value of the project.
(10 pts)
Depreciation is used to match the expense of an asset to the income that the asset
helps the company earn. Depreciation is the decrease in value of assets. The more
value as depreciated the less cash flow a company will have. For tax purposes,
businesses can deduct the cost of the tangible assets they purchase as business
expenses. Depreciation does bring a positive effect on project, come to tax deduction.
5.
Provide examples of at least one of the following as it relates to the project: (5 pts
each)
a.
Sunk Cost
If AirJet invested $3,000,000 in a machine that will not bring any gain to the
company, the cost of this machine will be sunk cost.
b.