Question

Byers, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $1,680,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1,950,000 in annual sales, with costs of $1,060,000. The project requires an initial investment in net working capital of $150,000, and the fixed asset will have a market value of $175,000 at the end of the project. Assume that the tax rate is 34 percent and the required return on the project is 14 percent.

Requirement 1:

What are the net cash flows of the project for the following years?

Requirement 2:

What is the NPV of the project?

Answer 1

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

Years	Cash Flow
Year 0	-$1,830,000
Year 1	$777,800
Year 2	$777,800
Year 3	$1,043,300

Calculate of Annual Cash Flow

Annual Sales	19,50,000
Less : Costs	10,60,000
Less: Depreciation [$1,680,000 / 3 Years]	5,60,000
Net Income Before Tax	3,30,000
Less : Tax at 34%	1,12,200
Net Income After Tax	2,17,800
Add Back : Depreciation	5,60,000
Annual Cash Flow	7,77,800

Year 0 Cash outflow

Year 0 Cash outflow = Initial Investment + Working Capital

= -$1,680,000 - $150,000

= -$1,830,000

Year 1 Cash Flow = $777,800

Year 2 Cash Flow = $777,800

Year 3 Cash Flow

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

= $777,800 + $155,000 + [$175,000 x (1 – 0.34)]

= $777,800 + $155,000 + [$175,000 x 0.66]

= $777,800 + $155,000 + $115,500

= $1,043,300

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

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

= [$777,800/(1 + 0.14)¹] + [$777,800/(1 + 0.14)²] + [$1,043,300/(1 + 0.14)³] - $1,830,000

= [$777,800/1.14] + [$777,800 / 1.2996] + [$1,043,300/1.481544] - $1,830,000

= [$6,82,280.70 + $5,98,491.85 + $7,04,197.78] - $1,830,000

= $1,984,970.33 - $1,830,000

= $154,970.33

“Hence, the Project’s Net Present Value (NPV) will be $154,970.33”