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Your company's heating, ventilating, and A/C (HVAC) systems still work but are out-of-date A new system will cost $150,000, will last 20 years, and will be more energy-efficient It will save $22,500 in cash expenses each year It will provide tax-deductible depreciation expense each year (numbers for each year are provided) Your expected tax rate is 25% Your hurdle rate for this project is 10% 124 Ist et le Pantal Analyse Tax Cash From Dollar Va Ye Year www Lawan 300.000 22.00 LE BE 14 SWE To S. Y 503 Vet Veis 400 * 1122 123 SHE Payback Method Analysis Year 1 2 3 4 5 MONO Annual After-Tax Cash Inflows $18,281 19,582 19,379 19,192 19.018 18,857 18,708 18,571 18,548 Cumulative Amount Required Cash Payback to Reach $150,000 $ 18,281 $131,719 37,863 112,137 57,242 92,758 76,434 73,566 95,452 54,548 114,309 35,691 133,017 16,983 151,588 170,136 8 9 Eh 12-18 me of Reham (RR) Example Tar Savingstoep Sum of Art Cash Flow 150.0001 10. TO 3100 11.00 204 2.31 1 TS TS TO TRO 1. 18 18:57 1854 TEATS 1 LET TILSA 1 US 10 11 14 12 1113 14 15 1 T 17 16 TS 16 TES TA 1673 18 14 18.548 1 15 18 18.54 16 TAS TOON Exhibit 12-10 B D Internal Rate of Return (IRR) Example C After-Tex Expense Tax-Savings from Depr. Savings Tax Shield Year 0 3 1 2 3 4 5 0 6 7 0 10 B 11 9 12 10 13 11 14 12 15 13 16 14 $16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16.675 16,875 16,875 16,875 16,875 16,875 16,875 $1,406 2,707 2,504 2,317 2,143 1,982 1.833 1,696 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 837 Sum of Net After-Tax Cash Flows S(150,000) 18.281 19,582 19,379 19,192 19,018 18,857 18,708 18,571 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 837 17 15 18 16 19 17 20 18 21 19 22 20 23 21 24 25 IRR 11.00% The NPV analysis shows the expected return exceeds the hurdle rate. Are there important assumptions that make this analysis tenuous? If so, what specific assumptions? What factors go into determining the project's hurdle rate? Do you think this project's hurdle rate should be higher or lower than the company's cost of capital? Why? The Payback method analysis says it will take 8 years to recover the initial investment. Is there a flaw in this analysis? . Would you invest in something that took 8 years to pay back? . Another investment, to develop a new product, also has an expected IRR of 11%. Which project would you choose? Why? . Would you choose to invest in this new HVAC system? Why or why not? Your company's heating, ventilating, and A/C (HVAC) systems still work but are out-of-date A new system will cost $150,000, will last 20 years, and will be more energy-efficient It will save $22,500 in cash expenses each year It will provide tax-deductible depreciation expense each year (numbers for each year are provided) Your expected tax rate is 25% Your hurdle rate for this project is 10% 124 Ist et le Pantal Analyse Tax Cash From Dollar Va Ye Year www Lawan 300.000 22.00 LE BE 14 SWE To S. Y 503 Vet Veis 400 * 1122 123 SHE Payback Method Analysis Year 1 2 3 4 5 MONO Annual After-Tax Cash Inflows $18,281 19,582 19,379 19,192 19.018 18,857 18,708 18,571 18,548 Cumulative Amount Required Cash Payback to Reach $150,000 $ 18,281 $131,719 37,863 112,137 57,242 92,758 76,434 73,566 95,452 54,548 114,309 35,691 133,017 16,983 151,588 170,136 8 9 Eh 12-18 me of Reham (RR) Example Tar Savingstoep Sum of Art Cash Flow 150.0001 10. TO 3100 11.00 204 2.31 1 TS TS TO TRO 1. 18 18:57 1854 TEATS 1 LET TILSA 1 US 10 11 14 12 1113 14 15 1 T 17 16 TS 16 TES TA 1673 18 14 18.548 1 15 18 18.54 16 TAS TOON Exhibit 12-10 B D Internal Rate of Return (IRR) Example C After-Tex Expense Tax-Savings from Depr. Savings Tax Shield Year 0 3 1 2 3 4 5 0 6 7 0 10 B 11 9 12 10 13 11 14 12 15 13 16 14 $16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16,875 16.675 16,875 16,875 16,875 16,875 16,875 16,875 $1,406 2,707 2,504 2,317 2,143 1,982 1.833 1,696 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 1,673 837 Sum of Net After-Tax Cash Flows S(150,000) 18.281 19,582 19,379 19,192 19,018 18,857 18,708 18,571 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 18,548 837 17 15 18 16 19 17 20 18 21 19 22 20 23 21 24 25 IRR 11.00% The NPV analysis shows the expected return exceeds the hurdle rate. Are there important assumptions that make this analysis tenuous? If so, what specific assumptions? What factors go into determining the project's hurdle rate? Do you think this project's hurdle rate should be higher or lower than the company's cost of capital? Why? The Payback method analysis says it will take 8 years to recover the initial investment. Is there a flaw in this analysis? . Would you invest in something that took 8 years to pay back? . Another investment, to develop a new product, also has an expected IRR of 11%. Which project would you choose? Why? . Would you choose to invest in this new HVAC system? Why or why not