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Chicago Value Company Case

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1. Explain the inputs into 1) the net initial investment outlay at year 0, the initial investment $200,000 which include taxes and delivery, and the cost to install the equipment $12,500. The total net cost $212,500. 2) The depreciation tax savings in each year of the projects economic life, this will show how much the tax savings will be depreciated each year using the MACRS method 3) the projects incremental cash flows? This shows the company profit for each of the eight years.

Net Cost MACRS Tax Rate Depreciation Tax Savings

$ 212,500 0.20 $ 42,500 40% $ 17,000

$ 212,500 0.32 $ 68,000 40% $ 27,200

$ 212,500 0.19 $ 40,375 40% $ 16,150

$ 212,500 0.12 $ 25,500 40% $ 10,200

$ 212,500 0.11 $ 23,375 40% $ 9,350

$ 212,500 0.06 $ 12,750 40% $ 5,100

2. What is the project's NPV? The Net Present Value is $36,955.09 Explain the economic rationale behind the NPV. Economists found much of their analyses on a marketplace where supply and demand are based on the perceptions of present value and scarcity. The Net Present Value (NPV) are calculations used to estimate the value over a lifetime which in this case would be of Chicago Valve's standard petroleum valve systems. NPV allows decision makers to compare various alternatives on a similar time scale by converting all options to current dollar figures. Could the NPV of this particular project be different for Lone Star Petroleum Company than for one of Chicago Valve's other potential customers? A project is deemed acceptable if the net present value is positive over the expected lifetime of the project.

Project Net Cash Flows

Year Net Cost Depreciation Tax Saving After-Tax Cost Savings Net Cash Flow

0 -212,500 -212,500

1 17000 36000 53000

2 27200 36000 63200

3 16150 36000 52150

4 10200 36000 46200

5 9350 36000 45350

6 5100 36000 41100

7 0 36000 36000

8 0 36000 36000

3. Calculate the proposed project's IRR. The proposed project IRR is 16.20% explain the rationale for using the IRR to evaluate capital investment projects. The Internal Rate of Return (IRR) is a capital budgeting method used to decide whether they should make loam term investments. The IRR is defined as any discount rate that results in a net present value of zero and is usually interpreted as the expected return generate by the investment. Could the IRR for this project differ for Lone Star versus for another customer? Yes, because the companies did not make the same amount. In general if the IRR is greater than the project's cost of capital the project will add value for the company.

4. Suppose one of Lone Star's executives typically uses the payback as a primary capital budgeting decision tool and wants some payback information. What is the project's payback period? The payback period would be 3.6 years for recovery what is the rationale behind the use of payback as a project evaluation tool? The rationale is to determine how long it will take to recover the initial investment of $212,500. The initial investment of $212,500 will be recovered before the 8 years of depreciation. It will be recovered between the 3rd and 4th year, 3.96 years. What deficiencies does payback have as a capital budgeting decision method? The decision made to use the Payback Period is a return method to maximize value. Does payback provide any useful information regarding capital budgeting decisions? Chicago Valve has a number of different types of products: some that are relatively expensive, some that are inexpensive, some that have very long lives, and some with short lives. Strictly as a sales tool, without regard to the validity of the analysis, would the payback be more help to the sale staff for

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