Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.41 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life. The project is estimated to generate $1,775,000 in annual sales, with costs of $685,000. The project requires an initial investment in net working capital of $380,000, and the fixed asset will have a market value of $375,000 at the end of the project.

a.	If the tax rate is 23 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.)
b.	If the required return is 9 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

    

Answer 1

(a)- Project’s Year 0, Year 1, Year 2 and Year 3 Cash Flow

Years	Cash Flow
Year 0	-$2,790,000
Year 1	$1,024,067
Year 2	$1,024,067
Year 3	$1,692,817

Calculate of Annual Cash Flow

Annual Sales	1,775,000
Less : Costs	685,000
Less: Depreciation [$2,410,000 / 3 Years]	803,333
Net Income Before Tax	286,667
Less : Tax at 23%	65,933
Net Income After Tax	220,734
Add Back : Depreciation	803,333
Annual Cash Flow	1,024,067

Year 0 Cash outflow

Year 0 Cash outflow = Initial Investment + Working Capital

= -$2,410,000 + $380,000

= -$2,790,000

Year 1 Cash Flow = $1,024,067

Year 2 Cash Flow = $1,024,067

Year 3 Cash Flow

Year 3 Cash Flow = Annual cash flow + Working capital + After-tax market value

= $1,024,067 + $380,000 + [$375,000 x (1 – 0.23)]

= $1,024,067 + $380,000 + [$375,000 x 0.77]

= $1,024,067 + $380,000 + $288,750

= $1,692,817

(b)-Net Present Value (NPV) of the Project

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

= [$1,024,067 / (1 + 0.09)¹] + [$1,024,067 / (1 + 0.09)²] + [$1,692,817 / (1 + 0.09)³] - $2,790,000

= [$1,024,067 / 1.09] + [$1,024,067 / 1.18810] + [$1,692,817 / 1.295029] - $2,790,000

= $939,510.70 + $861,936.43 + $1,307,165.06 - $2,790,000

= $318,612.19

“Hence, the Project’s Net Present Value (NPV) will be $318,612.19”