Question

PLEASE SHOW CALCULATOR INPUTS

Reynolds Metals is considering a project with a life of 4 years that will produce annual operating cash flows of $57,000. During the life of the project, inventory will be lowered by $28,000, accounts receivable will increase by $15,000 and accounts payable will increase by $6,000. The project requires the purchase of equipment at an initial cost of $104,000 that will be depreciated straightline to a zero book value over the life of the project. Ignore bonus depreciation The equipment will be salvaged at the end of the project creating an aftertax cash inflow of $22,000. At the end of the project, net working capital will return to its normal level. What is the NPV of this project given a required return of 16%?

Answer 1

1. Depreciation = cost/life
   • 104000/4 = 26000
2. Change in Working capital investments = -28000+15000-6000 = -19000 that is it will be negative
3. We can ignore the effect of taxes on the OCF as no tax rate is given
4. NPV is calculated below:

   • Year	CF	Discount Factor		Discounted CF
     0	$   -85,000.00	1/(1+0.16)^0=	1	1*-85000=	$   -85,000.00
     1	$    57,000.00	1/(1+0.16)^1=	0.862068966	0.862068965517241*57000=	$    49,137.93
     2	$    57,000.00	1/(1+0.16)^2=	0.743162901	0.743162901307967*57000=	$    42,360.29
     3	$    57,000.00	1/(1+0.16)^3=	0.640657674	0.640657673541351*57000=	$    36,517.49
     4	$    57,000.00	1/(1+0.16)^4=	0.552291098	0.552291097880475*57000=	$    31,480.59
     4	$    22,000.00	1/(1+0.16)^4=	0.552291098	0.552291097880475*22000=	$    12,150.40
     4	$   -19,000.00	1/(1+0.16)^4=	0.552291098	0.552291097880475*-19000=	$   -10,493.53
     				NPV = Sum of all Discounted CF	$    76,153.17

   • Initial investment = 104000-19000 = -85000
   • OCF is not impacted by depreciation as there are no taxes
   • In the final year, the salvage value of the equipment is an inflow and the working capital investment which was and inflow earlier is now and outflow.
   • So the NPV = 76153.17 and as it is positive, we should invest in this project.