Question

Gateway Communications is considering a project with an initial fixed assets cost of $1.76 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $234,000. The project will not change sales but will reduce operating costs by $384,500 per year. The tax rate is 34 percent and the required return is 10.9 percent. The project will require $49,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

• $117,989

• $160,744

• $155,559

• $112,859

• $149,576

Answer 1

NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

Given: Required rate of return for project is 10.9%

Calculation of NPV of the project

Particulars	Period	Amount	PVF @ 10.9%	Present Value
Cash Outflows:
Initial cost of Fixed Asset	0	($1,760,000.00)	1	($1,760,000.00)
Working Capital investment	0	($49,000.00)	1	($49,000.00)
Cash Inflows:
Cash Inflows for 10 years (note 1)	1-10	$313,610.00	5.914008349	$1,854,692.16
Sale Value of asset net of tax (note 2)	10	$154,440.00	0.35537309	$54,883.82
Recovery of working capital (note 3)	10	$49,000.00	0.35537309	$17,413.28
Net Present Value				$117,989.26

Notes :

1. Calculation of Operating Cash Flows

Cash Inflows:	Amount
Savings in operating cash flows	$384,500.00
Less: Depreciation (note 1.1)	$(176,000.00)
Profit before tax	$208,500.00
Less : Tax @ 34%	$(70,890.00)
Profit after tax	$137,610.00
Add: Depreciation	$176,000.00
Total Cash Inflows	$313,610.00

1.1 Calculation of Depreciation

Original Price	$1,760,000.00
Less: salvage value	$-
Depreciable value	$1,760,000.00
Life	10 years
Depreciation	$176,000.00

2. Calculation of Sale Value of asset net of tax

Sale Value of Fixed asset	$234,000.00
Less: WDV of Asset	$-
Profit on Sale of Asset	$234,000.00
Less: Tax @34%	$(79,560.00)
Sale Value of asset net of tax	$154,440.00

3. Recovery of Working capital at the end of the project is considered as Cash Inflow.

ANS. A) $117,989

Note :
PVF(r,t) = (1/(1+r))^n
PVAF = (1/(1+r))^1 + (1/(1+r))^2 +...+(1/(1+r))^n
or you can use Present value factor tables