Question

a company is considering a new 3-year expansion project that requires an initial fixed asset investment of $5.076 million. the fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $394,800. the project requires an initial investment in net working capital of $564000. the project estimated to generate $4512000 in annual sales, with costs of $1804800. the tax rate is 33 percent and the required return on the project is 18 percent. calculate npv and irr*** of this project. should the project be accepted or rejected?

Answer 1

1]	`Cost of fixed assets	$      5,076,000
	+Increase in NWC	$          564,000
	=Initial investment	$      5,640,000
2]	Annual sales	$      4,512,000
	-Annual costs	$      1,804,800
	-Depreciation [5076000/3]	$      1,692,100
	=NOI	$      1,015,100
	-Tax at 33%	$          334,983
	=NOPAT	$          680,117
	+Depreciation	$      1,692,100
	=Annual OCF	$      2,372,217
3]	After tax salvage value [394800*(1-33%)]	$          264,516
	+Recovery of NWC	$          564,000
	After tax terminal cash inflow	$          828,516
4]	CALCULATION OF NPV:
	PV of annual OCF = 2372217*(1.18^3-1)/(0.18*1.18^3) =	$      5,157,847
	+PV of terminal cash inflows = 828516/1.18^3 =	$          504,260
	Total PV of cash inflows	$      5,662,108
	-Initial investment	$      5,640,000
	=NPV	$            22,108
5]	CALCULATION OF IRR:
	IRR is that discount rate for which NPV = 0
	It is to be found out by trial and error, by
	discounting with different discount rates till 0
	NPV is reached.
	Discounting with 19%:
	PV of annual OCF = 2372217*(1.19^3-1)/(0.19*1.19^3) =	$      5,076,347
	+PV of terminal cash inflows = 828516/1.19^3 =	$          491,654
	Total PV of cash inflows	$      5,568,001
	-Initial investment	$      5,640,000
	=NPV	$          (71,999)
	IRR lies between 18% and 19% as 0 NPV would be
	obtained between them.
	By simple interpolation, IRR = 18%+1%*22108/(22108+71999)	18.23%
6]	As the NPV is positive, the project should be
	accepted.