Question

Company AAA is considering a new project. They have paid a market research firm $5,000 to evaluate viability of the potential investment. The company is expected to sell 80,000 units at $3 each, operating expenses equal to 35% of sales, and fixed cost equal to $30,000 every year. The plan for the company is to operate for 4 years. The company also needs to build its inventory, which requires an upfront investment of $8,000. To start its operations, the company bought today new equipment worth of $160,000, which will depreciate straight line over the next 4 years. At the end of the investment horizon you will be able to sell these assets for $20,000. Assume the tax rate is 20%, and that projects with similar risk have a required return (i.e., discount rate) of 10%.

(SHOW YOUR WORK. Correct answers with no formulas/calculations receive no credit)

NOTE: You can show your Excel table in the box below for partial credit, but you are still expected to write your answers and your calculations in the boxes below parts (a)-(g).

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a) Find the Operating Cash Flows for each year (show your work/calculations).

b) Find the change in net working capital (∆NWC) for each year (show your work/calculations).   

c) Find Net Capital Spending (NCS) for each year, and the after tax cash flow from the sale of assets in year 4 (show your work/calculations).

  

d) Find the CFFA for each year (show your work/calculations).

e) Find the NPV of this project. (show your work/calculations).

f) Find the IRR of the project. (show your work/calculations).

g) Should you invest in the project and why?

Answer 1

(a)Calculation of Operating after tax cashflows
Particulars	0	1	2	3	4
Sales Revenue		240000	240000	240000	240000
Variable cost @ 35%		84000	84000	84000	84000
Fixed Cost		30000	30000	30000	30000
PBDT		126000	126000	126000	126000
Depreciation (Cost - Salvage)/ Life		35000	35000	35000	35000
PBT		91000	91000	91000	91000
Tax @ 20%		18200	18200	18200	18200
PAT		72800	72800	72800	72800
Depreciation		35000	35000	35000	35000
Operating Cashflow		107800	107800	107800	107800
Working Capital	8000	8000	8000	8000	0
(b)Net Working capital Changes ( NWC)	-8000	0	0	0	8000
(c)Net capital spending (NCS)	-160000	0	0	0	20000
(d)CFFA	-168000	107800	107800	107800	135800
(Operating Cashflow + NWC + NCS

(e & f)Calculation of NPV and IRR

Calculation of NPV and IRR
Year	CFFA	PVF @ 10^	PV	PVF @54 %	PV
1	107800	0.9091	98000.00	0.6479	69841.27
2	107800	0.8264	89090.91	0.4197	45248.64
3	107800	0.7513	80991.74	0.2719	29315.60
4	135800	0.6830	92753.23	0.1762	23926.17
	PVIF		360835.87		168331.68
	PVOF		168000
	NPV		192835.87

Since PV of all cashflow at 54 % are approx equals tothe cost of investment . Hence IRR is 54%(Approx)

(g) Yescompany should invest in this projest, Since NPV is positive.