Question

PADICO is considering an investment project. The project requires an initial $5 million outlay for equipment and machinery. Sales are projected to be $2.5 million per year for the next four years. The equipment will be fully depreciated straight-line by the end of year 4. The cost of goods sold and operating expenses (not including depreciation) are predicted to be 30% of sales. The equipment can be sold for $500,000 at the end of year 4.Padico also needs to add net working capital of $100,000 immediately. The networking capital will be recovered in full at the end of the fourth year. .Assume the tax rate is 40% and the cost of capital is 12% A-what is the initial investment B-what is the OCF C-what is the terminal value ?D-What is the NPV of this investment I NEED TO SEE EACH STEP SOLUTION WRITING THE ANSWER ONLY IS CONSIDERED WRONG

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Abdul-Rahim Taysir

Answer 1

A. Initial Investment = 51,00,000

Particulars	Amount
Initial Investment (A)	50,00,000
Net Working Capital (B)	1,00,000
Net Initial Investment (A+B)	51,00,000

B. OCF

Particulars	Year 1	Year 2	Year 3	Year 4
OCF (COGS+WC)	8,50,000	8,50,000	8,50,000	7,50,000

C. Terminal Value (Salvage Value+WC Recovered) = 5,00,000+1,00,000 = 6,00,000

PV of Terminal Value = 6,00,000*(1/1.12^4) = 3,81,210.847

Note: The symbol '^' stands for 'to the power of'.

D. NPV

		Year 1	Year 2	Year 3	Year 4
	Particulars	Amount	Amount	Amount	Amount
A	Sales	25,00,000	25,00,000	25,00,000	25,00,000
B	Cost of Goods Sold (A*30%)	7,50,000	7,50,000	7,50,000	7,50,000
C	Working Capital	1,00,000	1,00,000	1,00,000
D	Depreciation (See Working Note)	11,25,000	11,25,000	11,25,000	11,25,000
E	Total Operating Expenses (B+C+D)	19,75,000	19,75,000	19,75,000	18,75,000
F	Profit before Tax (A-E)	5,25,000	5,25,000	5,25,000	6,25,000
G	Tax @40% (F*40%)	2,10,000	2,10,000	2,10,000	2,50,000
H	Profit after Tax (F-G)	3,15,000	3,15,000	3,15,000	3,75,000
I	Add back Depreciation	11,25,000	11,25,000	11,25,000	11,25,000
J	Cash Inflow (H+I)	14,40,000	14,40,000	14,40,000	15,00,000
K	Terminal Value (Salvage Value+WC)				6,00,000
L	Total Cashflow (J+K)	14,40,000	14,40,000	14,40,000	21,00,000
M	Discounting Factor @12%	0.892857143	0.797193878	0.711780248	0.635518078
N	PV of Cashflow (L*M)	12,85,714.29	11,47,959.18	10,24,963.56	13,34,587.96
	PV of Total Cash Inflow (1)	47,93,224.99
	PV of Total Cash Outflow (2)	51,00,000.00
	NPV (1-2)	-3,06,775.01

Working Note: Calculation of Depreciation:

Cost of Equipment = 50,00,000

Salvage Value of Equipment = 5,00,000

Depreciable Value = 50,00,000-5,00,000 = 45,00,000

As, depreciation is on Staright Line method the depreciation charged for each year will be equal.

Hence, Depreciation = 45,00,000/4 = 11,25,000 each year.