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

Answer 1

A)

Initial investment = Outlay for equipment and machinery + Investment in net working capital

Initial investment = $ 5,000,000 + $ 100,000 = $ 5,100,000

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B)

Cost of goods sold and operating expenses =  30% of sales = 0.30 $ 2,500,000 = $ 750,000

OCF = ( Sales - Cost of goods sold and operating expenses - depreciation ) ( 1 - tax rate ) + depreciation

OCF = ( $ 2,500,000 - $ 750,000 - $ 1,250,000 ) ( 1 - 0.40) + $ 1,250,000

OCF = $ 1,550,000

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C)

Terminal value = Sales proceeds from selling the equipment - taxes on sales proceeds + Recovery of working capital

Terminal value = $ 500,000 - 0.40 $ 500,000 + $ 100,000

Terminal value = $ 400,000

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D)

NPV of the investment = - Initilal investment + Present value of OCF + Present value of terminal value

NPV of the investment = - $ 137901.3 - $ 137901