Edward Finance Assingment Help With Solution
Edward is considering starting a business. The processing equipment costs are estimated at $245,000, and building at $100,000. He estimates his working capital need at $20,000.
Edward thinks that he would like to run the business for 10 years and then do something else as the peak demand for his product would have subsided. Details of his operating costs are as under:
1) He estimates his initial revenue for the first year would be $220,000 with an increase of 5% per year for the 10-year project life.
2) Returns on products by customers are estimated at 7% of revenues for all years.
3) Cost of goods sold (COGS), which is the total of all operating expenses to make the product are estimated as 35% of the revenues.
4) Edward believes that the business will be started in the month of January and can be sold at the end of 10 years.
a. The equipment will be depreciated on a MACRS basis with a 7-year property class.
The building will be depreciated as real property. Assume the business will be operational in the 1st month of the year, and will be sold in the last month. Based on this, the first year’s depreciation will be 2.461% of the cost of real estate, and subsequent years will have a depreciation of 2.564%. As the business will be sold as an operating entity, the last year will have full depreciation that Edward will claim for the building.
b. Working capital will be recovered as part of the price that Edward will get for the business.
5) Edward estimates his selling and administrative expenses as under:
a. Selling expenses are 10% of revenue in year 1, increasing by 0.1% every year. This means that the 2nd year selling expenses will be 10.1% of that year’s revenue, the 3rd year selling expenses will be 10.2% of that year’s revenue, and so on.
b. Administrative expenses are 2% of revenue in year 1, increasing by 0.5% every year. This means that the 2nd year administrative expenses will be 2.5%of that year’s revenue, the 3rd year selling expenses will be 3.0%of that year’s revenue, and so on.
c. Research expenses will be $24,000 in the first year, and increase by 5% every year.
d. Marketing expenses are 5% of revenue in year 1, increasing by 0.5% every year. This means that 2nd year marketing expenses will be 5.5%of that year’s revenue, 3rd year marketing expenses will be 6.0%of that year’s revenue, and so on.
6) Income taxes can be assumed to be a flat 28% for all income levels.
7) Edward will draw a suitable salary for working for the company whichis included in the COGS.
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Questions:
1) Edward believes that he can get bank financing for 75% of the assets (equipment, building and working capital) over a 7-year period at an APR of 7%, compounded monthly. He plans to put in the rest of the money with a loan from his family, which he will pay back in 10 equal yearly installments with no interest. His salary for working for the company is included in the COGS.If Edward estimates that the business can be sold at the end of the 10 year period for $900,000:
a. What would be the internal rate of return for the project? (For calculating the IRR, take the year 0 cash flow as the total of the amounts invested in equipment, building and working capital.)
b. What will be the NPV for his investment if the MARR was 12%?
c. What will be the equal uniform annual worth that the business will be able to generate over the 10-year period?
2) There is a possibility that Edward can invest in another set of equipment which costs $70,000 less but which will generate revenues of only $200,000 in the first year, with the rest of the cost structure staying the same as described above. He still believes that he can get bank financing for 75% of the assets including working capital over a 7 year period at an APR of 7%, compounded monthly. He plans to put in the rest of the money with a loan from his family, which he will pay back in 10 equal yearly installments with no interest. If Edward estimates that the business can be sold at the end of the 10-year period for $700,000:
a. What would be the internal rate of return for the project? (For calculating the IRR, take the year 0 cash flow as the total of the amounts invested in equipment, building and working capital.)
b. What will be the NPV for his investment if the MARR was 12%?
c. What will be the annual worth that the business will be able to generate over the 10-year period?
3) If Edward believes that he needs to get at least a bonus of $20,000 per year for the extra effort that he will be putting into the business, for what price should the best scenario option that you selected sell for at the end of 10 years? The bonus will be treated as an additional expense and will be included as a part of the COGS.
4) If Edward finds that his product qualifies for an investment credit of 25% of his project cost (equipment, building and working capital), which he can claim as income at the end of the first year for which he will have to pay taxes at the regular rate in the first year, would his decision change? Why? For calculating the IRR, take the year 0 cash flow as the total of the amounts invested in equipment, building and working capital.
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