K&G Chemical Company has just received a special subcontracting job from one of its clients. This two-year project requires the purchase of a special-purpose painting sprayer for $60,000. This equipment falls into the MACRS five-year class. After the subcontracting work is completed at the end of two years, the painting sprayer will be sold for $40,000 (actual dollars). The painting system will require an increase in the company's networking capital (for spare-parts inventory, such as spray nozzles) of $5,000. This investment in working capital will be fully recovered at the project termination. The project will bring in additional annual revenue of $120,000 (today's dollars), but it is expected to incur an additional annual operating cost of $60,000 (today's dollars). It is projected that, because of inflation, there will be sales-price increases at an annual rate of 5%, which implies that annual revenues will also increase at an annual rate of 5%. Anannual increase of 4% for expenses and working-capital requirements is expected. The company has a marginal tax rate of 30%, and it uses a market interest rate of 15% for project evaluation during the inflationary period. The firm expects general inflation of 8% during the project period.(a) Compute the after-tax cash flows in actual dollars.(b) What is the rate of return on this investment (real earnings)?(c) Is this special order profitable?
K&G Chemical Company has just received a special subcontracting job from one of its clients. This two-year project requires the purchase of a special-purpose painting sprayer for $60,000. This equipment falls into the MACRS five-year class. After the subcontracting work is completed at the end of two years, the painting sprayer will be sold for $40,000 (actual dollars). The painting system will require an increase in the company's networking capital (for spare-parts inventory, such as spray nozzles) of $5,000. This investment in working capital will be fully recovered at the project termination. The project will bring in additional annual revenue of $120,000 (today's dollars), but it is expected to incur an additional annual operating cost of $60,000 (today's dollars). It is projected that, because of inflation, there will be sales-price increases at an annual rate of 5%, which implies that annual revenues will also increase at an annual rate of 5%. An
annual increase of 4% for expenses and working-capital requirements is expected. The company has a marginal tax rate of 30%, and it uses a market interest rate of 15% for project evaluation during the inflationary period. The firm expects general inflation of 8% during the project period.
(a) Compute the after-tax cash flows in actual dollars.
(b) What is the rate of
(c) Is this special order profitable?
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