BUSINESS FINANCE

CAPITAL BUDGETING

NAME: Spring 2020 Problem 1: Version #2

The Jon Company is examining purchasing a new piece of equipment. Jon, the owner, has a problem in that he only can make decisions using Excel and they have told him that the computer system will be down for the next month. He has hired you to evaluate the proposal and make the final recommendation as he sits in his office staring at a blank computer screen.

The old system is currently three years old and had an original production life of eight years. It had cost $4,800,000 and was depreciated as 100% bonus property. Jon estimated that it could be sold for $300,000 at the end of its production life and this is still true.

The new will take one year to build and install and require an investment of $2,800,000 today and $800,000 one year from now, have a production life of six years and be depreciated as 100% bonus property. It will also increase working capital by $100,000 when it is ready for use.

The old is projected to produce cash revenue of $2,400,000 this coming year and that will decrease 15% per year for the rest of its production life. Cash expenses are expected to be 50% of revenue (not including taxes). The old will be used until the new is put in service.

The new will produce cash revenue of $1,900,000 its first year of production, $3,100,000 its second year, $3,700,000 its third year, $2,900,000 its fourth year, $2,450,000 its fifth year and $1,845,000 its last year. Cash expenses are expected to be 45% of revenue (not including taxes). We expect to sell it for $800,000 at the end of its production life. We estimate we can sell the working capital for $100,000 at that time.

Jon estimates that the old could be sold for $1,375,000 when the new is ready for use.

Jon requires a 18% return on this project and has a 30% tax rate. Based on net present value, should he purchase the new system? SHOW ALL WORK!!!!!

The IRR on this project would be: