Question

You are evaluating a project with a 4 year life. Sales revenue is projected to be $320,000 in year 1, $400,000 in year 2, $424,000 in year 3, and $475,000 in year 4. Operating expenses (excluding depreciation) are $200,000 per year. The project requires an initial investment in equipment of $240,000 which will be depreciated straight-line to zero over its four-year life. However, the actual market value of the equipment at the end of year 4 is expected to be $23,000. The level of net working capital required in each year is projected to be 10% of sales in the following year. The tax rate is 40% and the required return on the project is 15%.

(a) What is operating cash flow in the second year (t=2) of the project? Show all your work and clearly identify your final answer. (25 points)

(b) What is the investment in net working capital in the third year (t=3) of the project? Indicate clearly whether this would be a positive or negative number in your cash flow worksheet. Show all your work and clearly identify your final answer. (25 points)

(c) What is the after-tax cash flow from the sale of the equipment in year 4? Show all your work and clearly identify your final answer. (25 points)

Answer 1

	The cash flows of the project are worked out below:
		0	1	2	3	4
	Sales		$   3,20,000	$    4,00,000	$ 4,24,000	$   4,75,000
	Operating expenses		$   2,00,000	$    2,00,000	$ 2,00,000	$   2,00,000
	Depreciation (240000/4)		$       60,000	$        60,000	$    60,000	$      60,000
	NOI		$       60,000	$    1,40,000	$ 1,64,000	$   2,15,000
	Tax at 40%		$       24,000	$        56,000	$    65,600	$      86,000
	NOPAT		$       36,000	$        84,000	$    98,400	$   1,29,000
	Add: Depreciation		$       60,000	$        60,000	$    60,000	$      60,000
	OCF		$       96,000	$    1,44,000	$ 1,58,400	$   1,89,000
	Capital expenditure	$   2,40,000
	Change in NWC	$       32,000	$         8,000	$          2,400	$       5,100	$     -47,500
	After tax salvage value of the equipment = 23000*(1-40%) =					$      13,800
	Project cash flows	$ -2,72,000	$       88,000	$    1,41,600	$ 1,53,300	$   2,50,300
	PVIF at 15% [PVIF = 1/1.15^t]	1	0.86957	0.75614	0.65752	0.57175
	PV	$ -2,72,000	$       76,522	$    1,07,070	$ 1,00,797	$   1,43,110
	NPV	$   1,55,499
	ANSWERS:
a]	Operating cash flow for second year	$   1,44,000
b]	Investment in NWC in t=3	$         5,100	Positive
c]	After tax cash flow from the sale of the equipment = 23000*(1-40%) =	$       13,800