Case 95 Essay

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QUESTIONS 1. Table 1 contains the complete cash flow analysis based on GP Manufacturing’s basic information. Explain the inputs into 1) the net initial investment outlay at year 0, 2) the depreciation tax savings in each year of the project’s economic life, and 3) the project’s incremental cash flows? 1. Net initial investment outlay is $302,040. (Cost of new system + Installation) + (Proceeds from old equipment + Tax on proceeds + Removal cost) = Total cost + NCF (old) = 303,000 +-960 2. Tax depreciation savings = (36% tax rate) x (depreciation of each year) Depreciation for each year based on MACRS 5-year (Wikipedia) 3. Incremental cash flows = (Deprn. Tax savings + A.T. cost savings) each year [pic]2. What is the project’s NPV? Explain the economic rationale behind the NPV. Could the NPV of this particular project be different for GP Manufacturing than for one of Chino Material Systems Inc.’s other potential customers? Explain. NPV= 20,085.81 (cell B69) NPV helps investors determine projects profitability. Net Present Value is an estimate of future cash flows so it will be the same for anyone using those values 3. Calculate the proposed project’s IRR. Explain the rationale for using the IRR to evaluate capital investment projects. Could the IRR for this project differ for GP Manufacturing versus for another customer? IRR= 14.1% (cell B70) IRR is used to decide whether investors should make long term investments. IRR depends on how much a company actually makes so it will be different for everyone 4. Suppose one of GP Manufacturing’s executives typically uses the payback as a primary capital budgeting decision tool and wants some payback information. a. What is the project’s payback period? Projected payback period = 4.28 (cell B73) b. What is the rationale behind the use of payback as a project evaluation tool?

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