Determine the internal rate of return for the proposed sale.

Corporate finance question | Business & Finance homework help

The internal rate of return (IRR) for the proposed sale can be calculated using the following formula: ((Present Value of Cash Flows – Initial Investment)/Initial Investment)*100. Because this is the projected sales of the coming fiscal year, the present value of cash flows is $40 million. Additionally, the initial investment is $50 million because this is what it would take to acquire the Colton Industries boat division. Plugging these figures into our equation we get: (($40 million – $50 million)/$50 million)*100 = -20%. The Internal Rate of Return (IRR) for the proposed sale is therefore -20%.

Given that Colton’s opportunity cost of capital is 10%, and its marginal tax rate 30%, it can be concluded that selling the boat division is not a good idea as its IRR (-20%) falls below both these figures. Colton is likely to suffer an economic loss by selling the boat division. Paraguay’s foreign manufacturing competition means that there is no expectation for improvement or growth in this sector, despite the fact that resources have been invested to reverse current trend of four percent decline annually. Board directors should therefore reject any proposal and instead look at alternative options which might offer positive financial returns with fewer associated risks.

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