Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.18 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life. The project is estimated to generate $1,730,000 in annual sales, with costs of $640,000. The project requires an initial investment in net working capital of $290,000, and the fixed asset will have a market value of $240,000 at the end of the project. a. If the tax rate is 24 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? b. If the required return is 12 percent, what is the project's NPV?

Answer 1

Initial investment (year 0)
fixed assets investment	-2180000
working capital	-290000
Year 0 cash flow is	-2470000

	Year 1	Year2	Year 3
Sales	1730000.00	1730000.00	1730000.00
Less : costs	-640000.00	-640000.00	-640000.00
less : depreciation (2180000/3)=	-726666.67	-726666.67	-726666.67
Profit before tax	363333.33	363333.33	363333.33
less : tax @24%	-87200.00	-87200.00	-87200.00
Profit after tax	276133.33	276133.33	276133.33
Add : Depreciation	726666.67	726666.67	726666.67
Add :market value at end	-	-	240000.00
Less : tax on capital gain 24%			-57600.00
Add : Working capital received at end			290000.00
Free cash flow	1002800.00	1002800.00	1475200.00

Calcultion of NPV
i = 12%
Year	0	1	2	3
free Cash flow	-2470000	1002800.00	1002800.00	1475200.00
PVF = 1/(1+i)^n=	1	0.8928571429	0.7971938776	0.7117802478
for year 1 PVF =1/(1+20%)^1
and so on
PV= FCf * PVF	-2470000	895357.1429	799426.0204	1050018.222
NPV (total of pv)	274801.3848
NPV is $274801.38. So project should be accepted.

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