Question

The Market Place is considering a new four-year expansion project that requires an initial fixed asset investment of $1.67 million. The fixed asset will be depreciated straight-line to zero over its four-year tax life, after which time it will have a market value of $435,000. No bonus depreciation will be taken. The project requires an initial investment in net working capital of $198,000, all of which will be recovered at the end of the project. The project is estimated to generate $1,850,000 in annual sales, with costs of $1,038,000. The tax rate is 21 percent and the required return for the project is 16.4 percent. What is the net present value?

Answer 1

Annual depreciation = 1,670,000 / 4

Annual depreciation = 417,500

Initial investment = Cost of equipment + net working capital

Initial investment = 1,670,000 + 198,000 = $1,868,000

Operating cash flow from year 1 to year 4 = ( Sales - costs - depreciation)( 1 - tax ) + depreciation

Operating cash flow from year 1 to year 4 = (  1,850,000 - 1,038,000 - 417,500)( 1 - 0.21) + 417,500

Operating cash flow from year 1 to year 4 = $729,155

Year 4 non operating cash flow = Market value + net wroking capital - tax( market value - book value)

Year 4 non operating cash flow = 435,000 + 198,000 - 0.21( 435,000 - 0 )

Year 4 non operating cash flow = 435,000 + 198,000 - 91,350

Year 4 non operating cash flow = $541,650

NPV = Present value of cash inflows - present value of cash outflows

NPV = -1,868,000 + 729,155 / ( 1 + 0.164)¹ + 729,155 / ( 1 + 0.164)² + 729,155 / ( 1 + 0.164)³ + 729,155 / ( 1 + 0.164)⁴ + 541,650 / ( 1 + 0.164)⁴

NPV = $451,180.7