Question

Litchfield Design is evaluating a 3-year project that would involve buying a new piece of equipment for 340,000 dollars today. The equipment would be depreciated straight-line to 20,000 dollars over 2 years. In 3 years, the equipment would be sold for an after-tax cash flow of 34,000 dollars. In each of the 3 years of the project, relevant revenues are expected to be 212,000 dollars and relevant costs are expected to be 111,000 dollars. The tax rate is 50 percent and the cost of capital for the project is 9.78 percent. What is the NPV of the project?

Answer 1

Depreciation=(cost-book value)/2=(340000-20000)/2=160,000 for first 2 years.

I have provided all the formulas and how to arrive each line item in the below table

To find the NPV use NPV function in EXCEL

=NPV(rate,Year1 to year3 cashflows)-Initial cost

=NPV(9.78%,Year1 to year3 cashflows)-340000

NPV=-$48,973.40

Cost of Capital	9.78%
	Year0	Year1	Year2	Year3	Remarks
Revenues		212000	212000	212000	Given
Costs		-111000	-111000	-111000	Given
Depreciation		-160000	-160000		(340000-20000)/2=160000. this is for 2 years
Operating profit		-59000	-59000	101000	Revenue-costs-depreciation
Taxes@50%		29500	29500	-50500	You will get benefits for first two years because negatiive operating profit.
Profits		-29500	-29500	50500	Operating profit-taxes
Depreciation		160000	160000	0	Add back depreciation because these are non cash items and shown for the tax benefits
Cashflows		130500	130500	50500	Profits+depreciation
After tax Equipment value				34000	In year3
After tax cashflows	-340000	130500	130500	84500	Cashflows+after tax equipment value
NPV	-48973.40