Question

ABC Corporation has hired you to evaluate a new FOUR year project for the firm. The project will require the purchase of a $772,200.00 work cell. Further, it will cost the firm $57,200.00 to get the work cell delivered and installed. The work cell will be straight-line depreciated to zero with a 20-year useful life. The project will require new employees to be trained at a cost of $58,400.00. The project will also use a piece of equipment the firm already owns. The equipment has been fully depreciated, but has a market value of $6,200.00. Finally, the firm will invest $11,100.00 in net working capital to ensure the project has sufficient resources to be successful.

The project will generate annual sales of $923,000.00 with expenses estimated at 39.00% of sales. Net working capital will be held constant throughout the project. The tax rate is 39.00%.The work cell is estimated to have a market value of $469,000.00 at the end of the fourth year. The firm expects to reclaim 81.00% of the final NWC position.The cost of capital is 14.00%.

a) What is the cash flow to start the project in year 0?

b) What is the yearly operating cash flow for the project?

c) What is the terminal cash flow for the project?

d) What is the NPV the project if we end the project after 4 years?

Answer 1

A).Cash flow to start the project at year 0 is $879906

cash flow (year 0)= cost of work cell + increase in Net working capital +NSV of old equipment + net training expense after-tax

1.cost of work cell = ($772,200+$57,200) = (829400)

2.increase in Net working capital = (11100)

3.NSV of old equipment ($6,200- .39*(7400-0) = ($3782)

4.net training expense after-tax ($58,400* (1-.39) = ($35624)

cash flow (year 0)=( 829400 + 11100+ 3782+ 35624) = $879906

B).Yearly operating Cash Flow is 359621.6

Yearly operating Cash Flow

Annual Sales	$923,000
Expenses ( 39% of 923000 )	(359970)
Depreciation (829400 / 20)	(41470)
Earnings before tax	521560
Taxes (39%)	(203408.4)
Earnings after tax	318151.6
Add Non cash expenses(depreciation)	41470
Yearly operating Cash Flow	359621.6

C).Terminal cash flow of the project is $553854

Terminal cashflow = NSV of project assets + Recovered Net working capital

1.NSV of project assets

NSV of project assets

Book value of asset (BV)	Depreciation basis - Accumulsted Depreciation
	= ($772,200+$57,200) - (4 * 41470)
	=663520
Market value (MV)	$469,000
NSV of project assets	= MV - tax rate (MV-BV)
	=$469,000 - .39 *($469,000- 663520)
	=$544863

2.Recovered Net working capital

Recovered Net working capital = Net working capital (NWC) * .81

=$11,100 * .81 = $8991

Therefore Terminal cashflow =$544863 + $8991 = $553854

D).NPV of the project if we end the project after 4 years is  510388

CALCULATIONS:-

Year	0	1	2	3	4
cost of work cell (756000+ 56000)	(829400)
increase in Net working capital	(11100)
NSV of old equipment (7400- .38*(7400-0)	(3782)
net training expense after-tax (60300* (1-.39)	(35624)
Yearly operating Cash Flow		359621.6	359621.6	359621.6	359621.6
recovered Net working capital (NWC * .81)					$8991
NSV of project assets					$544863
Total cash flows	($879906)	359621.6	359621.6	359621.6	913481.6
PV of $1 Factor for 14%	1	.877	.769	.675	.592
Discounted Cash Flow	(879906)	315388	276549	242744.58	540781

NPV = PV of future expected net cash inflows – initial investment

Initial investment  = 865074

NPV = (315388+276549+242744.58+540781) - 865074

NPV=   1375462.84 - 865074

NPV = 510388