Question

Orange Valley Shipping is considering a project that would last for 2 years. The project would involve an initial investment of 84,000 dollars for new equipment that would be sold for an expected price of 76,000 dollars at the end of the project in 2 years. The equipment would be depreciated to 24,000 dollars over 6 years using straight-line depreciation. In years 1 and 2, relevant annual revenue for the project is expected to be 73,000 dollars per year and relevant annual costs for the project are expected to be 20,000 dollars per year. The tax rate is 50 percent and the cost of capital for the project is 6.11 percent. What is the net present value of the project?

Answer 1

Time line		0	1	2
Cost of new machine		-84000
=Initial Investment outlay		-84000
					100.00%
Sales			73000	73000
Profits	Sales-variable cost		53000	53000
-Depreciation	(Cost of equipment-salvage value)/no. of years		-10000	-10000	64000	=Salvage Value
=Pretax cash flows			43000	43000
-taxes	=(Pretax cash flows)*(1-tax)		21500	21500
+Depreciation			10000	10000
=after tax operating cash flow			31500	31500
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)			38000
+Tax shield on salvage book value	=Salvage value * tax rate			32000
=Terminal year after tax cash flows				70000
Total Cash flow for the period		-84000	31500	101500
Discount factor=	(1+discount rate)^corresponding period	1	1.0611	1.1259332
Discounted CF=	Cashflow/discount factor	-84000	29686.17472	90147.443
NPV=	Sum of discounted CF=	35833.61784