Question

Bourque Enterprises is considering a new project. The project will generate sales of $1.7 million, $2.4 million, $2.3 million, and $1.8 million over the next four years, respectively. The fixed assets required for the project will cost $2.7 million and will be eligible for 100 percent bonus depreciation. At the end of the project, the fixed assets can be sold for $185,000. Variable costs will be 25 percent of sales and fixed costs will be $475,000 per year. The project will require NWC equal to 20 percent of sales that must be accumulated in the year prior to sales. The required return on the project is 13 and the tax rate is 24 percent. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

NPV of the project is $0.89 Mn.

Cash Inflows include- Sales for 4 years, salvage value of the asset in 4th year, depreciation benefit during 4 years, working capital inflow in 2nd, 3rd and 4th year.

Cash outflows include- Assets purchase at year 0, Variable costs and Fixed costs for 4 years, working capital outflow in Year 0 and Year 1.

Sales have been provided to us from Year 1 to Year 4.

Cost of the Asset has been provided in Year 0 and the salvage value has been provided in Year 4.

Depreciation benefit for each year is calculated as :

Tax rate * [Cost of Asset/4]. Since, we've been told that the assets can be fully written off even though it has some salvage value, we've divided the cost by 4 which gives us $675,000. Multiplying it by Tax rate of 24%, we get the Tax benefit as $162,000 for each year.

Variable Costs have been calculated as 25% of sales of that year.

We need to have working capital as 20% of next year sales in advance. This is the working capital balance that we need to maintain each year but the Inflow/Outflow will depend on the previous year's balance. To calculate the working capital inflow/outflow each year, we need to deduct last year's working capital balance from the current year's balance. it's explained as per below:

NPV Factor for each year is calculated as 1/(1+0.13)^year.

Then we calculate PV of Inflows and PV of Outflows and sum both we get the NPV which is $0.8858 Mn.