Question

Xis considering purchasing a new piece of heavy machinery for $18.50 million. The machinery will be depreciated to zero book value over10 years using the straight-line depreciation method but is expectedto have a residual market value (selling price) at the end of the 10 years equal to $0.90 million. During the first year the machinery is expected to increase the company’s revenues by $1.70 million and, in addition, enable the company to save $1.50 million in employee salaries. Both of these numbers are to remain constant for the rest of themachinery’s useful life. The incometax rate is 18%; the company will use 80% equity and 20% debt to finance to investment; the risk-free rate in the country is 2.90%, the company’s beta has been estimated 1.10, and the market risk premium is 4.90% while cost of debt (before tax) is 3.50%.

a)Estimate the project’s cash flows.   (4 Points)

b)Estimate the project’s WACC.   (2 Points)

c)Estimate the project’s NPV.   (1 Point)

d) Estimate the project’s IRR.    (1 Point)

 

Answer 1

we will present the solution in excel:

NPV<0, IRR<WACC, the project is unprofitable