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1 Page APA Written Assignment Written Problem 1: The Drillago Company is involved in searching for locations in which to drill for oil.  The firm’s curre

1 Page APA Written Assignment

Written Problem 1:

The Drillago Company is involved in searching for locations in which to drill for oil.  The firm’s curre

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1 Page APA Written Assignment

Written Problem 1:

The Drillago Company is involved in searching for locations in which to drill for oil.  The firm’s current project requires an initial investment of $15 million and has an estimated life of 10 years.  The expected future cash inflows for the project are below.

Future Cash Inflows

Year       

Cash Inflow                   

1

600,000

2

1,000,000

3

1,000,000

4

2,000,000

5

3,000,000

6

3,500,000

7

4,000,000

8

6,000,000

9

8,000,000

10

12,000,000

a.  What is the project’s NPV?  Show your work.

b.  Is the project acceptable under the NPV technique?  Explain

c.  Calculate the project’s IRR.  Show your work.

d.  Is the project acceptable under the IRR technique?  Explain

e.  Did the NPV and IRR techniques produce the same results?

f.  Calculate the payback period for the project.  Show your work.

g.  If the firm usually accepts projects that have payback periods between 1 and 7 years, is this project acceptable?  Why or why not?

Written Problem 2:

Damon Corporation, a sports equipment manufacturer, has a machine currently in use that was originally purchased three years ago for $120,000.  The firm depreciates under MACRS using a five-year recover period.  Once removal and cleanup costs are taken into consideration, the expected net selling price for the present machine will be $70,000.  Damon can buy a new machine for a net price of $160,000 (including installation costs of $15,000).  The proposed machine will be depreciated under MACRS using a five-year recovery period.  If the firm acquires the new machine its working capital needs will change:  Accounts receivable will increase $15,000, inventory will increase $19,000, and accounts payable will increase $16,000.  Earnings  before depreciation, interest and taxes (EBDIT) for the present machine are expected to be $95,000 for each of the successive five years.  For the proposed machine, the expected EBDIT for each of the next five years are $105,000, $110,000, $120,000, $120,000, and $120,000 respectively.  The corporate tax rate (T) for the firm is 40%

Damon expected to be able to liquidate the proposed machine at the end of its five year usable life for $24,000 (after paying removal and cleanup costs).  The present machine is expected to net $8,000 upon liquidation at the end of the same period.  Damon expects to recover its net working capital investment upon termination of the project.  The firm is subject to a tax rate of 40%

a.  Calculate the initial investment (show  your work)

b.  Prepare a depreciation schedule for both the proposed and the present machine.  Both machines are depreciated under MACRS using a five-year recovery period, but remember, the present machine has only three years of depreciation remaining.

c.  Calculate the operating cash flows for Damon Corporation for both the proposed and the present machine.  Show your work.

d.  Calculate the terminal cash flow associated with the project.  Show your work.

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