Question

LEZ Enterprises, Inc. has been considering the purchase of a new manufacturing facility for $700,000. The facility is to be depreciated on a straight line basis over 14 years. It is expected to have no value after those 14 years. Cash flow from depreciation are considered to be risk-free and so they should be discounted at the risk-free rate. Operating revenues from the facility are expected to be $160,000 during the first year. The revenues are expected to increase at the rate of 2.2% per year which is also expected to be the inflation rate. Production costs in the first year are $25,000 and they are expected to remain constant each year. The project ends after 14 years. LEZ’s cost of capital is 15%. Its corporate tax rate 21%. The risk-free rate 3%. What is the NPV of this project?

Answer 1

	I	Initial Investment	$700,000
		Present Value(PV) of Cash Flow
		(Cash Flow)/((1+i)^N)
		N=Year of cash flow
		i=Discount Rate=3%=0.03 for depreciation tax shield
		i=Discount Rate=Cost of capital =15%=0.15 for Operating Income
		DEPRECIATION CASH FLOW
	N	Year	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14
	A	Annual Depreciation =(700000/14)		$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000
	B=A*21%	Depreciation Tax Shield		$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	$10,500	SUM
	C=B/(1.03^N)	Present Value of Depreciation Tax shield		$10,194	$9,897	$9,609	$9,329	$9,057	$8,794	$8,537	$8,289	$8,047	$7,813	$7,585	$7,364	$7,150	$6,942	$118,609
		OPERATING CASH FLOW