I've been doing this one over and over, consistently getting wrong answers. I know the process of how to do it generally, but I feel I make mistakes in calculating either depreciation or changes in net working capital. Here's the problem:
Aguilera Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows:
Year Unit Sales
1 74,800
2 86,240
3 93,280
4 100,320
5 81,840
Production of the implants will require $1,320,000 in net working capital to start and additional net working capital investments each year equal to 19 percent of the projected sales increase for the following year. Total fixed costs are $792,000 per year, variable production costs are $211 per unit, and the units are priced at $286 each.
The equipment needed to begin production has an installed cost of $18,480,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property (MACRS Table). In five years, this equipment can be sold for about 17 percent of its acquisition cost. AAI is in the 35 percent marginal tax bracket and has a required return on all its projects of 17 percent.
What is the NPV of the project?
What is the IRR of the project?
Thanks for any and all help!
NPV= 13
IRR= 50
To calculate the NPV (Net Present Value) and IRR (Internal Rate of Return) of the project, you need to follow these steps:
1. Determine the cash inflows and outflows for each year of the project.
- Cash Inflows: Calculate the revenue generated by unit sales. Revenue is equal to the number of units sold multiplied by the selling price.
- Cash Outflows: Calculate the total costs incurred, including fixed costs, variable production costs, and changes in net working capital.
2. Calculate the depreciation expense using the MACRS method for the equipment acquired.
- Determine the depreciable basis, which is the acquisition cost of the equipment.
- Apply the appropriate MACRS depreciation rate based on the asset's classification as seven-year property.
- Calculate the depreciation expense for each year using the selected MACRS depreciation rate.
3. Calculate the tax liability for each year.
- Multiply the taxable income (revenue minus total costs minus depreciation expense) by the corporate tax rate (35%) to determine the tax liability.
4. Calculate the net cash flow for each year.
- Add the depreciation expense to the taxable income to obtain the net income before taxes.
- Subtract the tax liability from the net income before taxes to find the net income after taxes.
- Add the net income after taxes to the depreciation expense to calculate the net cash flow.
5. Calculate the present value of each year's net cash flow.
- Apply the required return rate (17%) to discount each year's net cash flow.
- Discount each year's net cash flow using the appropriate discount factor based on the time period.
6. Sum up the present values of all cash flows to determine the Net Present Value (NPV).
- Subtract the initial investment (equipment cost and initial net working capital) from the sum of the present values of all cash flows.
7. Use a trial-and-error approach or financial software to find the IRR (Internal Rate of Return).
- Adjust the discount rate until the NPV is zero, using either a trial-and-error approach or financial software.
By following these steps and performing the necessary calculations, you should be able to find the NPV and IRR for the given project.