Question

The following are the final values to the data that you have been estimating up to this point: You can borrow funds from your bank at 3%. The cost to install the needed equipment will be $105,000 and this cost is incurred prior to any cash is received by the project. The gross revenues from the project will be $25,000 for year 1, then $27,000 for years 2 and 3. Year 4 will be $28,000 and year 5 (the last year of the project) will be $23,000. The expected annual cash outflows (current project costs) are estimated at being $13,000 for the first year, then $12,000 for years 2, 3, and 4. The final year costs will be $10,000. Your tax rate is 30% and you plan to depreciate the equipment on a straight-line basis for the life of the equipment. After 5 years the equipment will stop working and will have a residual (salvage) value of $5,000). The discount rate you are assuming is now 7%. Perform the final NPV calculations and provide a narrative of how you calculated the computations and why. Then provide a summary conclusion on whether you should continue to pursue this business opportunity.

Answer 1

Solution:

Computation of Annual after tax cash flows
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Gross revenue	$25,000.00	$27,000.00	$27,000.00	$28,000.00	$23,000.00
Expected outflows	$13,000.00	$12,000.00	$12,000.00	$12,000.00	$10,000.00
Depreciation	$20,000.00	$20,000.00	$20,000.00	$20,000.00	$20,000.00
Income before taxes	-$8,000.00	-$5,000.00	-$5,000.00	-$4,000.00	-$7,000.00
Income tax expense (Benefit)	-$2,400.00	-$1,500.00	-$1,500.00	-$1,200.00	-$2,100.00
Net Income (Loss)	-$5,600.00	-$3,500.00	-$3,500.00	-$2,800.00	-$4,900.00
Add: Depreciation	$20,000.00	$20,000.00	$20,000.00	$20,000.00	$20,000.00
Net Cash inflows	$14,400.00	$16,500.00	$16,500.00	$17,200.00	$15,100.00

Computation of Net Present Value
Particulars	Now	Year 1	Year 2	Year 3	Year 4	Year 5
Cost of equipment	-$105,000
Yearly net cash flows		$14,400	$16,500	$16,500	$17,200	$15,100
Salavage value of equipment						$5,000
Total cash flows	-$105,000	$14,400	$16,500	$16,500	$17,200	$20,100
PV Factor	1.00000	0.93458	0.87344	0.81630	0.76290	0.71299
Present Value	-$105,000	$13,458	$14,412	$13,469	$13,122	$14,331
Net present value	-$36,209

AS NPV is negative, therefore i will not pursue this investment opportunity.