Capital Investment Analysis under Inflation: Management of Excello Retail Corporation is considering the purchase of energy- saving
Question:
Capital Investment Analysis under Inflation: Management of Excello Retail Corporation is considering the purchase of energy- saving equipment costing $250.000.
The equipment has an expected useful life of seven years, at which time it will have no salvage value. The equipment will be depreciated for tax purposes over five years as follows: Year 1, $50.000: Year 2. $80.000; Years 3-5, $40,000 per year.
Present energy costs for the activities related to this equipment are $120,000 per year before taxes. The equipment will save 60 percent of these costs.
Working capital will be reduced by an estimated 5 percent of the initial year's after-tax cash energy cost savings. The working capital reduction will be an additional 5 percent each year with inflation in future years until Year 7, when it is assumed that the company will have to restore the entire working capital savings. The expected inflation rate is 5 percent per year. The company's marginal tax rate is 40 percent, and its nominal cost of capital is 18.80 percent, after considering expected inflation of 5 percent per year.
Required: Compute the net present value of the project.
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