1 Problem 12-19 -- New Project Analysis 100819 Your Answers 3 Holmes Manufacturing is considering a new machine that costs $250,000 and would reduce 4 pre-tax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS method 5 to depreciate the machine, and management thinks the machine would have a value of $23,000 6 at the end of its 5-year operating life. The applicable depreciation rates are 33%, 45%, 15% and 7% Problem Questions Calculate the project's.... a. 1 NPV: a.2 IRR: a.3 MIRR: a.4 Payback: b. Assume management is unsure about the $90,000 cost savings -- the figure could deviate by as much as plus or minus 20%. What would be the NPV under each of these situations? b.1 + 20%: b.2 - 20% 7 8 as discussed in Appendix 12A. Net operating working capital would increase by $25,000 initially, but it would be recovered at the end of the project's 5-year life. Holmes marginal tax rate is 40%, c. Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine's salvage value, and the net operating working capital (NOWC) requirement. She asks ... Calculate the project's expected NPV, its standard deviation, and its coefficient of variation... NPV: c.2 Standard Deviation: c.3 Coefficiant of Variation: c.4 Would you recommend the project be accepted? c.5 Why or why not? 9 and a 10% WACC is appropriate for the project. 10 11 a. Calculate the project's NPV, IRR, MIRR, and payback. 12 b. Assume management is unsure about the $90,000 cost savings - this figure could deviate by as 13 much as plus or minus 20%. What would be the NPV under each of these situations? 14 c. Suppose the CFO wants you to do a scenario analysis with different values for the cost of savings, 15 the machines salvage value and the net operating working capital (NOWC) requirement. 16 She asks you to use the following probabilities and values in the scenario analysis. 17 18 Scenario Probability Cost Savings Salvage Value NOWC 19 Worst case 0.35 $72,000 $18,000 $30,000 20 Base case 0.35 $90,000 $23,000 $25,000 Best case 0.35 $108,000 $28,000 $20,000 Problem Parameters New Manufacturing Machine Price Annual Reduction in Manufacturing Costs Year 5 Salvage Value Increase in NOWC Marginal Tax Rate WACC Values $250,000 $90,000 $23,000 $25,000 40% 10% 22 23 Calculate the project's expected NPV, its standard deviation, and its coefficient of variation. 24 Would you recommend that the project be accepted? Why, or why not? 25 26