Question

The local franchise of Jiffy Lube is thinking of buying a new lift for $80,000 that would make it easier to access the oil filter in customers' cars and save labor. The savings would increase over the project's 3-year life, in line with the projected growth of the business:

A B C D

1 Year 1 2 3

2 Cost savings 90,000 99,000 118,800

The machine is to be linearly depreciated to zero and will have no resale value after 3 years. The company uses a discount rate of 11% and has a tax rate of 21%.

Part 1

What is the free cash flow in year 3?

Part 2

What is the NPV?

Answer 1

Part 1:

Computation of FCF:

	Year 1	Year 2	Year 3
Cost savings	$90,000	$99,000	$118,800
Less: Depreciation ($ 80,000/3)	$26,666.67	$26,666.67	$26,666.67
EBIT	$63,333.33	$72,333.33	$92,133.33
Less: Tax @ 21%	$13,300.00	$15,190.00	$19,348.00
Net income	$50,033.33	$57,143.33	$72,785.33
Add: Depreciation	$26,666.67	$26,666.67	$26,666.67
Free cash flow	$76,700.00	$83,810.00	$99,452.00

Free cash flow in year 3 is $ 99,452

Part 2:

Computation of NPV:

NPV = PV of future cash inflow – Initial investment

Year	Computation of PV Factor	PV Factor @ 11 % (F)	Cash Flow (C)	PV (C x F)
0	1/ (1+0.11)0	1	-$80,000	-$80,000.00
1	1/ (1+0.11)1	0.9009009009009	$76,700	$69,099.0991
2	1/ (1+0.11)2	0.8116224332441	$83,810	$68,022.0761
3	1/ (1+0.11)3	0.7311913813010	$99,452	$72,718.4453
	NPV	$129,839.6205

NPV of the project is $ 129,840