Question
In: Finance
Cochran Inc. is considering a new three-year expansion project that requires an initial fixed asset investment...
Cochran Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $1,950,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,145,000 in annual sales, which costs $1,205,000. If the tax rate is 35%, , OCF is $838,500.Calculate the NPV using the required return of 14% using the cash flows from the previous problem. And Do some sensitivity analysis. Suppose the president lowered the tax rate to 30%. Calculate the NPV again using a 14% required return.
Solutions
Expert Solution
Net present Value (NPV) calculation:
| Year (t) | Initial investment | Depreciation amount (D) (Initial investment/3) | Annual sales | Annual cost | Before tax cash inflow (CF) | Taxable Income (CF - depreciation) | Income taxes (Taxable Income *35%) | Operating cash flow (OCF) (taxable income - taxes + depreciation) | PV of Net cash flow @14%= NCF/ (1+14%)^t |
| 0 | $1,950,000 | -$1,950,000 | -$1,950,000.00 | ||||||
| 1 | $650,000 | $2,145,000 | $1,205,000 | $940,000 | $290,000 | $101,500 | $838,500 | $735,526.32 | |
| 2 | $650,000 | $2,145,000 | $1,205,000 | $940,000 | $290,000 | $101,500 | $838,500 | $645,198.52 | |
| 3 | $650,000 | $2,145,000 | $1,205,000 | $940,000 | $290,000 | $101,500 | $838,500 | $565,963.62 | |
| NPV | -$3,311.55 |
Net present Value (NPV) of project at 35% tax rate is -$3,311.55. As the NPV is negative so the project is not acceptable.
NPV calculation at 30% tax rate:
| Year (t) | Initial investment | Depreciation amount (D) (Initial investment/3) | Annual sales | Annual cost | Before tax cash inflow (CF) | Taxable Income (CF - depreciation) | Income taxes (Taxable Income *30%) | Operating cash flow (OCF) (taxable income - taxes + depreciation) | PV of Net cash flow @14%= NCF/ (1+14%)^t |
| 0 | $1,950,000 | -$1,950,000 | -$1,950,000.00 | ||||||
| 1 | $650,000 | $2,145,000 | $1,205,000 | $940,000 | $290,000 | $87,000 | $853,000 | $748,245.61 | |
| 2 | $650,000 | $2,145,000 | $1,205,000 | $940,000 | $290,000 | $87,000 | $853,000 | $656,355.80 | |
| 3 | $650,000 | $2,145,000 | $1,205,000 | $940,000 | $290,000 | $87,000 | $853,000 | $575,750.70 | |
| NPV | $30,352.12 |
NPV of the project at 30% tax rate is $30,352.12. As the NPV is positive therefore project is acceptable.
Formulas used in excel calculation:
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