A 3-year project will cost $180 at the end of year 1 and is expected to produce operating profit before depreciation and amortization (EBITDA)of $80 in year 1, $100 in year 2, and $60 in year 3. Depreciation, both real and financial, will be calculated using straight-line depreciation over 3 years. The cost of capital is 10%, and the firm's marginal tax rate is 25%.
-Refer to the information above. Calculate the project IRR if 100% equity financing is used.

Question

Quizplus · Accepted Answer

Using the information provided, we can calculate the project's cash flows and then solve for the IRR using a financial calculator or spreadsheet software:

At t=0: -$180
At t=1: $80
At t=2: $100
At t=3: $60
Total cash flows: $60

IRR= 29.8%

Thus, the best choice is B) 29.8%. To calculate the project's IRR, we need to determine the cash inflows and outflows for each year of the project.

Year 0: Initial investment = -$180

Year 1: EBITDA - Taxes - Capital Expenditures = $80 - $20 - ($180/3) = $18.33

Year 2: EBITDA - Taxes - Capital Expenditures = $100 - $25 - ($180/3) = $38.33

Year 3: EBITDA - Taxes - Capital Expenditures = $60 - $15 - ($180/3) = $11.67 + Terminal value of assets = $60

To calculate the terminal value of assets, we need to determine the salvage value of the assets at the end of year 3. Since straight-line depreciation is used, the salvage value will be $0. Therefore, the terminal value of assets is the book value of the assets at the end of year 3, which is $180/3 = $60.

The cash flow for year 3 is the sum of the operating cash flow and the terminal value of assets:

Cash flow for year 3 = $11.67 + $60 = $71.67

Now we can use a financial calculator or Excel to calculate the project's IRR, which is approximately 29.8%.

Therefore, the best choice is B.

A 3-Year Project Will Cost $180 at the End of Year