A Capitol Corp management is expecting a project to generate

A) Capitol Corp. management is expecting a project to generate after-tax income of $66,190 in each of the next three years. The average book value of the project’s equipment over that period will be $212,570. If the firm’s investment decision on any project is based on an ARR of 37.5 percent

B) Hathaway, Inc., a resort management company, is refurbishing one of its hotels at a cost of $7,053,259. Management expects that this will lead to additional cash flows of $1,610,000 for the next six years. What is the IRR of this project? If the appropriate cost of capital is 12 percent, should Hathaway go ahead with this project?

The IRR of this project is:

Accounting rate of return is

:

Solution

Question A Year Cash Flow DF for 37.5% Discounted Cash Flow 0 -212570 1 $                  (212,570.00) 1 66190 0.7273 $                       48,138.18 2 66190 0.5289 $                       35,009.59 3 66190 0.3847 $                       25,461.52 NPV $                  (103,960.71) As the NPV @ ARR 37.5% is negative the Company shloud not accept the project Question B Year Cash Flow DF for 12% Discounted Cash Flow FOR IRR 7% DF for 7% Discounted Cash Flow 0 $ (7,053,259.00) 1 $              (7,053,259.00) 1 $                     (7,053,259.00) 1 $    1,610,000.00 0.8929 $                 1,437,500.00 0.93458 $                       1,504,672.90 2 $    1,610,000.00 0.7972 $                 1,283,482.14 0.87344 $                       1,406,236.35 3 $    1,610,000.00 0.7118 $                 1,145,966.20 0.81630 $                       1,314,239.58 4 $    1,610,000.00 0.6355 $                 1,023,184.11 0.76290 $                       1,228,261.29 5 $    1,610,000.00 0.5674 $                    913,557.24 0.71299 $                       1,147,907.75 6 $    1,610,000.00 0.5066 $                    815,676.11 0.66634 $                       1,072,810.98 NPV $                  (433,893.21) NPV $                           620,869.85 IRR =Ra + NPV @ Ra (Rb-Ra) Ra = Lower discount rate             NPV @ Ra - NPV @ Rb Rb = higher discount rate =0.07 + [ ((620869.85 X (.12 - .07)) / (620869.85 - (-433896.21)) =0.07 + (0.5886 X (.12 - .07)) 0.099 9.9%