Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.82 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $2,120,000 in annual sales, with costs of $815,000. The tax rate is 30 percent and the required return is 12 percent.

What is the project’s NPV?

Answer 1

Initial Investment Cost (Year 0 Cash Flow)

Initial Investment Cost = Initial Fixed asset Investment = $2,820,000

Annual Operating Cash Flow

Annual Operating Cash Flow = [(Annual Revenue - Costs) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($2,120,000 - $815,000) x (1 – 0.30)] + [($2,820,000 / 3 Years) x 0.30]

= [$1,305,000 x 0.70] + [$940,000 x 0.30]

= $913,500 + $282,000

= $1,195,500

Net Present Value (NPV) of the Project

Net Present Value (NPV) of the Project = Present Value of annual cash inflows – Initial Investment Cost

= CF1/(1 + t)¹ + CF2/(1 + r)² + CF3/(1 + t)³ – Initial Investment Cost

= $1,195,500/(1 + 0.12)¹ + $1,195,500/(1 + 0.12)² + $1,195,500/(1 + 0.12)³ – $2,820,000

= [($1,195,500/1.12) + ($1,195,500/1.25440) + ($1,195,500/1.404928)] - $2,820,000

= [$10,67,410.71 + $9,53,045.28 + $8,50,933.29] - $2,820,000

= $28,71,389.28 - $2,820,000

= $51,389.28

“Hence, the Net Present Value (NPV) of the Project will be $51,389.28”