Fuller Ford Company is considering the purchase of a vertical drill machine. The machine will cost $50,000 and will have an eight-year service life. The selling price of the machine at the end of eight years is expected to be $5,000 in today's dollars. The machine will generate annual revenues of $20,000 (today's dollars) but is expected to have an annual expense (excluding depreciation) of $8,000 (today's dollars). The asset is classified as a seven-year MACRS property. The project requires a working-capital investment of $10,000 at year 0. The marginal income-tax rate for the firm is averaging 35%. The firm's market interest rate is 18%.(a) Determine the internal rate of return of this investment.(b )Assume that the firm expects a general inflation rate of 5%, but that italso expects an 8% annual increase in revenue and working capital and a 6% annual increase in expenses, caused by inflation. Compute the real (inflation-free) internal rate of return. Is this project acceptable?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Fuller Ford Company is considering the purchase of a vertical drill machine. The machine will cost $50,000 and will have an eight-year service life. The selling price of the machine at the end of eight years is expected to be $5,000 in today's dollars. The machine will generate annual revenues of $20,000 (today's dollars) but is expected to have an annual expense (excluding depreciation) of $8,000 (today's dollars). The asset is classified as a seven-year MACRS property. The project requires a working-capital investment of $10,000 at year 0. The marginal income-tax rate for the firm is averaging 35%. The firm's market interest rate is 18%.
(a) Determine the internal rate of return of this investment.
(b )Assume that the firm expects a general inflation rate of 5%, but that it
also expects an 8% annual increase in revenue and working capital and a 6% annual increase in expenses, caused by inflation. Compute the real (inflation-free) internal rate of return. Is this project acceptable?

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