Question

Revenues generated by a new fad product are forecast as follows:

Year	Revenues
1	$60,000
2	40,000
3	30,000
4	10,000
Thereafter	0

Expenses are expected to be 30% of revenues, and working capital required in each year is expected to be 10% of revenues in the following year. The product requires an immediate investment of $81,000 in plant and equipment.

b. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 20%, what are the project cash flows in each year? Assume the plant and equipment are worthless at the end of 4 years. (Do not round intermediate calculations.)

c. If the opportunity cost of capital is 10%, what is the project's NPV? (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

b. If the the plant is depreciated over straight line for 4 years with 0 salvage value, depreciation = 81,000/4 = 20,250. The table below reports the projected cash flows. Table one is devised to calculate the tax after deducting depreciation, whereas table 2 is the actual projected cash flows without deducting depreciation since depreciation is not a cash flow items, its a book keeping expense.

The cash flow in year zero is negative due to the initial investment in machinery and the working capital required which is 10% of the following years revenue.

c. Table three shown below shows the NPV of the project using the discount rate (10%) which is the oppurtunity cost of capital. There is no calculation of NPV for the year zero since that is already the present value. The following years NPV are calculated by the Time Value of Money formula .

NPV is the cumulative NPV's from year 1-5 , after deducting the initial investment and working capital. As shown in the calculation, the NPV is positive which denotes a profitable cash statement .