Examples
Example A: …
Question: A widget manufacturer currently produces 200,000 units a year. It buys widget
lids from an outside supplier at a price of $2 a lid. The plant manager believes that it would
be cheaper to make these lids rather than buy them. Direct production costs are estimated to
be only $1.50 a lid. The necessary machinery would cost $150,000. This investment could be
written off for tax purposes using the seven-year tax depreciation schedule. The plant
manager estimates that the operation would require additional working capital of $30,000
but argues that this sum can be ignored since it is recoverable at the end of the 10 years. If
the company pays tax at a rate of 35 % and the opportunity cost of capital is 15 %, would you
support the plant manager’s proposal?
 State clearly any additional assumptions that you need to make.

Price
Costs
Profit/Margin
2Units
1,5Total Income
0,5Depreciations
200000
100000
21429
Examples
Example B: …
 Question: A widget manufacturer currently produces 200,000 units a
year. It buys widget lids from an outside supplier at a price of $2 a lid.
The plant manager believes that it would be cheaper to make these lids
rather than buy them. Direct production costs are estimated to be only
$1.50 a lid. The necessary machinery would cost $150,000. This
investment could be written off for tax purposes using the seven-year tax
depreciation schedule. The plant manager estimates that the operation
would require additional working capital of $30,000 but argues that this
sum can be ignored since it is recoverable at the end of the 10 years. If
the company pays tax at a rate of 35 % and the opportunity cost of
capital is 15 %, would you support the plant manager’s proposal?
 State clearly any additional assumptions that you need to make.
Examples
Example C: …
 Question: You can purchase
a turbo powered machine
tool gadget for $4,000. The
investment will generate
$2,000 and $4,000 in cash
flows for two years,
respectively. What is the
IRR on this investment?
 Answer:
Examples
Example C: …
 Question: You can purchase
a turbo powered machine
tool gadget for $4,000. The
investment will generate
$2,000 and $4,000 in cash
flows for two years,
respectively. What is the
IRR on this investment?
 Answer:
28.08 %
Examples
Example D: …
Company X is in the process of preparing a new investment project. Its realization
is associated with the purchase of new equipment worth 1.8 million leva.
Installation costs are 400 thousand leva, its transportation costs are 150 thousand
leva and the costs of designing, permits, etc. amounted in total to 160 thousand
leva. Putting into operation will lead to an increase in net working capital of 480
thousand leva, Due to installing the new equipment used equipment will be sold so
far for 400 thousand leva with book value of the last 200 thousand leva. Corporate
tax is 10%. The expected annual net cash flow from operation of the project is 840
thousand leva and the project duration is 5 years.
A. Define the gross and net investment.
B. Define whether the investment have to be made, using net present value if the
required rate of return is 12%.
C. Define the internal rate of return, modified internal rate of return and profitability
index of the project.
Examples
Example E: …
Company Y is in the process of preparing a new investment project, the projected
net amount of initial investment is 600 thousand Leva and duration of the project is 4
years. Estimates of the marketing department are for sales in the first year of 750
thousand Leva, each year they increased by 20% by the end of the project. Annual
operating costs excluding depreciation amounted to 80% of revenue and are
projected depreciation leva 120 thousand per year. At the end of the project are
expected to frequent the proceeds of liquidation of fixed assets amounting to 110
thousand Leva and release of net working capital of 80 thousand Leva. Corporate
tax rate is 10%. The coefficient beta of the company is 1.2, risk-free rate is 5.4% and
market risk premium is 8%.
A. Identify significant cash flows for project evaluation.
B. Determine the net present value, internal rate of return, modified internal rate of
return and profitability index of the project.