Question

Sonoco Inc is evaluating a 4-year project that requires $118,000 of new equipment. This equipment will be depreciated straight-line to a zero-book value over the life of the project. This project is expected to generate operating cash flows of $39,000 per year for four years. At the beginning of the project, inventory will be lowered by $9,000, accounts receivable will increase by $14,000, and accounts payable will increase by $11,000. At the end of the project, net working capital will return to its normal level and the equipment will be sold for $21,000, after taxes. What is the net present value given a required return of 13 percent?

Answer 1

Solution :

The Net present value of the project is = $ 13,204.16

= $ 13,204 ( when rounded off to the nearest dollar )

Note :

1. Since Net working capital of $ 6,000 is released in Year ' 0 ', it implies that there is an increase in cash inflow by $ 6,000 in Year " 0 ". This Cash inflow amount is deducted from the Initial Investment of $ 118,000 to arrive at the Net cash outflow in Year " 0 " or Initial Investment in the project.

Thus we have Initial Investment = Cost of New Equipment - Cash inflow due to decrease in net working capital in year " 0 "

= $ 118,000 - $ 6,000

2. As per the information given in the question, at the end of the project, net working capital will return to its normal level. This implies that a net cash outflow of $ 6,000 will occur in year 4 in order to bring the net working capital to its normal level. The same has been shown as a deduction in Year " 4 " .

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.