Question

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $4.158 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $323,400. The project requires an initial investment in net working capital of $462,000. The project is estimated to generate $3,696,000 in annual sales, with costs of $1,478,400. The tax rate is 31 percent and the required return on the project is 16 percent.

Required: (a) What is the project's year 0 net cash flow? (b) What is the project's year 1 net cash flow? (c) What is the project's year 2 net cash flow? (d) What is the project's year 3 net cash flow? (e) What is the NPV?

Answer 1

Years	Cash Flow
Project's year 0 net cash flow	-$4,620,000
Project's year 1 net cash flow	$1,959,804
Project's year 2 net cash flow	$1,959,804
Project's year 3 net cash flow	$2,644,950

Calculate of Annual Cash Flow

Annual Sales	36,96,000
Less : Costs	14,78,400
Less: Depreciation [$4,158,000 / 3 Years]	13,86,000
Net Income Before Tax	8,31,600
Less : Tax at 31%	2,57,796
Net Income After Tax	5,73,804
Add Back : Depreciation	13,86,000
Annual Cash Flow	19,59,804

Year 0 Cash outflow

Year 0 Cash outflow = Initial Investment + Working Capital

= -$4,158,000 - $462,000

= -$4,620,000

Year 1 Cash Flow = $1,959,804

Year 2 Cash Flow = $1,959,804

Year 3 Cash Flow

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

= $1,959,804 + $462,000 + [$323,400 x (1 – 0.31)]

= $1,959,804 + $462,000 + [$323,400 x 0.69]

= $1,959,804 + $462,000 + $223,146

= $2,644,950

Net Present Value (NPV) of the Project

Period	Annual Cash Flow ($)	Present Value factor at 16%	Present Value of Cash Flow ($)
1	1,959,804	0.862068966	1,689,486.21
2	1,959,804	0.743162901	1,456,453.63
3	2,644,950	0.640657674	1,694,507.51
TOTAL			4,840,447.35

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

= $4,840,447.35 - $4,620,000

= $220,447.35

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.