Question
Werner Enterprises is considering an investment in loss control equipment. The cost of the equipment is $200,000. The equipment will have a five-year life and
Werner Enterprises is considering an investment in loss control equipment. The cost of the equipment is $200,000. The equipment will have a five-year life and be depreciated on a straight-line basis with no salvage value. With the loss control equipment in place, cash revenues are projected to increase by $70,000 each year. Cash expenses are projected to increase by $15,000 per year. Werner pays taxes at a rate of 32 percent.
a. What equal annual cash flow (CF) will this project generate? Note: As cash revenues (CR) and cash expenses (CE) are the same each year, and straight-line depreciation is used; the cash flow will be equal each year. CF = CR CE taxes How is depreciation handled?
b. Werners cost of capital is 8.2 percent. What is the net present value (NPV) of this average-risk project?
c. Based on your answer is part b, is the internal rate of return (IRR) on this project greater than or less than 8.2 percent? What is the IRR of this investment?
d. What case can be made for marginal loss control projects?
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