Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.7 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 $2,400,000 in annual sales, with costs of $960,000. The tax rate is 35 percent and the required return is 15 percent. What is the project’s NPV? (20 Points) Hint: PVIFA = 1-(1+r)-N/r r is the period rate. N is payments or withdrawals.

Answer 1

Initial investment =    2700000  
Time (N) =   3  
Required return (r) = 15% or   0.15  
      
      
      
Calculation of annual cash flows      
Annual sales 2400000  
less: cost -960000  
less : Depreciation -900000  
(2700000/3)      

Profit before tax    540000  
less : tax@35% -189000  

Profit after tax 351000  
Add: Depreciation 900000  

Annual cash flows 1251000  
      
Present value of Cash inflows (PVIFA) =1-(1+r)-N/r or

Annual amount * (1-(1/(1+r)^n) / r      
=1251000 * (1-(1/(1+0.15)^3))/0.15      
=2856314.622      
      
NPV = Present value of cash inflow-initial investment      
2856314.622 -2700000   

=156314.6215      
      
So, NPV of investment is $156,314.62. So project is acceptable.     

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