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DOGSRULE Company is contemplating the purchase of a new piece of equipment that would cost $350,000. The equipment has a four-year life. It will depreciate straight-line. At the end of the project the company will sell the equipment for $40,000. You will save $130,000 before taxes per year and you will be able to reduce net working capital by $50,000. If the tax rate is 21%, what is the IRR?
a. Draw a timeline showing all cashflows. - In time zero, you must consider the initial cost of the equipment AND the reduction in net working capital. If you reduce the NWC, it is a positive cashflow to the project. Next, calculate depreciation and then OCF using OCF=EBIT+D-T. (You could alternatively use the "tax shield approach" and get the same OCF. OCF = (S-C)(1-t) + Dt. )Plot on the timeline. Then consider the AFTER-TAX salvage value of the project the final year. You also have to consider the NWC increase at the completion of the project.
b. If there is a hurdle rate of 11%, calculate the NPV. Should you accept or reject the project? Why?
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