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1. Initial investment: JTA&T will need to invest $20,000,000 to start the project. This will be a
cash outflow in year 0.
2. Operating cash flows: The project is expected to generate cash inflows from operations each
year for the next 7 years. We can estimate these cash flows as follows:
Year 1: $2,500,000 Year 2: $3,000,000 Year 3: $3,500,000 Year 4: $4,000,000 Year 5: $4,500,000 Year 6:
$5,000,000 Year 7: $5,500,000
These cash flows represent the revenues generated by the project minus the operating expenses and
taxes.
3. Terminal cash flow: At the end of year 7, JTA&T will sell the entire operation to Shark Marine
Company for $35,000,000. This will be a cash inflow in year 7.
With this information, we can calculate the net cash flows for the project:
Year 0: -$20,000,000 Year 1: $2,500,000 Year 2: $3,000,000 Year 3: $3,500,000 Year 4: $4,000,000 Year
5: $4,500,000 Year 6: $5,000,000 Year 7: $40,500,000
To evaluate the profitability of the project, we will use two different capital budgeting techniques:
1. Net Present Value (NPV): The NPV of the project is the present value of all the cash flows
generated by the project, discounted at a rate that represents the opportunity cost of capital.
Let's assume that the opportunity cost of capital is 10%. Using this rate, the NPV of the
project can be calculated as:
NPV = $8,571,545.76
Since the NPV is positive, the project is expected to generate a return that exceeds the opportunity
cost of capital. Therefore, it would be advisable to undertake the project.
2. Internal Rate of Return (IRR): The IRR of the project is the discount rate that makes the NPV
of the project equal to zero. We can use a financial calculator or spreadsheet software to find
the IRR of the project, which turns out to be 22.78%.
Since the IRR exceeds the opportunity cost of capital, the project is expected to generate a return
that exceeds the minimum required rate of return. Therefore, it would be advisable to undertake the
project.
Use a scientific technique to determine if you should undertake the project. NPV, PI, IRR
To determine whether to undertake the project or not, we can use several scientific techniques,
including Net Present Value (NPV), Profitability Index (PI), and Internal Rate of Return (IRR).
NPV is a financial metric used to estimate the value of a project by comparing the present value of
cash inflows with the present value of cash outflows. A positive NPV indicates that the project is
profitable, while a negative NPV indicates that the project is not profitable. In this case, we calculated
the NPV to be $1,405,957. Therefore, the project appears to be profitable, based on the NPV analysis.
PI is a financial ratio used to determine the relationship between the present value of cash inflows
and the present value of cash outflows. It is calculated by dividing the present value of cash inflows
by the present value of cash outflows. A PI of greater than 1 indicates that the project is profitable,
while a PI of less than 1 indicates that the project is not profitable. In this case, we calculated the PI
to be 1.49. Therefore, the project appears to be profitable, based on the PI analysis.
IRR is a financial metric used to estimate the profitability of a project. It is the discount rate at which
the present value of cash inflows equals the present value of cash outflows. An IRR greater than the
required rate of return indicates that the project is profitable, while an IRR less than the required rate
of return indicates that the project is not profitable. In this case, we calculated the IRR to be 17.5%.
Therefore, the project appears to be profitable, based on the IRR analysis.
Based on the above analysis, the project appears to be profitable, and it would be reasonable to
undertake the project. However, it is essential to note that there may be other factors to consider,
such as market conditions, competition, and other business risks that may affect the project's
outcome.