investment analysis practice problem. a fertilizer dealer is considering the purchase of a new piece...

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INVESTMENT ANALYSIS PRACTICE PROBLEM

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Page 1: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

INVESTMENT ANALYSIS

PRACTICE PROBLEM

Page 2: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application
Page 3: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application rates of fertilizer across a field.

• This new machine will cost him $150,000. He expects to increase his cash flows by $20,000 in year one, $25,000 in year two, and $35,000 in year 3 and $50,000 for the next 2 years.

• The estimated value of the machine at the end of 5 years is $85,000. Depreciation is calculated using the straight line method using a salvage value of $85,000 and a life of 5 years.

Page 4: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• (a) What is the payback period?

• (b) What is the simple rate of return?

Page 5: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• To get the annual cash flows average the annual cash flow estimates: (20,000+25,000+35,000+50,000+50,000)/5 = $36,000

• Depreciation is calculated as: (150,000-85,000)/5 = 65,000/5 = $13,000

• Payback Period = $150,000/$36,000 = 4.17 years

• Simple Rate of Return = ($36,000-13,000)/($150,000) = $23,000/$150,000 = 0.153 = 15.3 %

Page 6: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• Evaluate the purchase of the new fertilizer application machine using after tax cash flows with a marginal tax rate of 20 % using

• (a) Net Present Value (using an 8% cost of capital) over a 5 year time horizon

• (b) Internal Rate of Return.

Page 7: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

Year Before Tax CF

Depr Taxable Inc

Inc Tax

After Tax CF

1 20,000 13,000 7,000 1,400 18,600

2 25,000 13,000 12,000 2,400 22,600

3 35,000 13,000 22,000 4,400 30,600

4 50,000 13,000 37,000 7,400 42,600

5 50,000 13,000 37,000 7,400 42,600

Page 8: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• CF0 = - 150,000• CF1 = 18,600• CF2 = 22,600• CF3 = 30,600• CF 4 = 42,600• CF 5 = 42,600 + 85,000 = 127,600

• I/Y = 10%

• NPV = $16,903

• IRR = 13.15%

Page 9: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• The fertilizer dealer can finance the new machine with the equipment dealer. Terms of the loan would be 20% down payment financed over 5 years at 8.5% using a level payment amortization schedule. Evaluate the investment using

• (a) Net Present Value (using an 12% cost of capital) over a 5-year time horizon

• (b) Internal Rate of Return.

Page 10: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• Amount of down payment = $150,000 * 0.20 = $30,000

• Amount financed = $150,000 - $30,000 = $120,000

• Amount of annual payments:

• PV = 120,000• P/Y = 1• I/Y = 8.5 %• N = 5

• PMT = - 30,452

Page 11: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

Year Before Tax CF

Depr Interest Expense

Taxable Inc

Inc Tax

Loan Payment

After Tax CF

1 20,000 13,000 10,200 -3,200 -640 30,452 -9,812

2 25,000 13,000 8,479 3,521 704 30,452 -6,156

3 35,000 13,000 6,611 15,389 3,078 30,452 1,470

4 50,000 13,000 4,584 32,416 6,483 30,452 13,065

5 50,000 13,000 2,386 34,614 6,923 30,452 12,625

Page 12: INVESTMENT ANALYSIS PRACTICE PROBLEM. A fertilizer dealer is considering the purchase of a new piece of equipment the will allow him to vary the application

• CF0 = - 30,000• CF1 = - 9,812• CF2 = - 6,156• CF3 = 1,470• CF 4 = 13,065• CF 5 = 12,625 + 85,000 = 97,625

• I/Y = 12%

• NPV = $21,076

• IRR = 22.42%