Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.35 million. The fixed asset falls into the 3-year MACRS class (MACRS schedule). The project is estimated to generate $1,745,000 in annual sales, with costs of $648,000. The project requires an initial investment in net working capital of $320,000, and the fixed asset will have a market value of $285,000 at the end of the project.

  

a.	If the tax rate is 22 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to two decimal places, e.g., 1,234,567.89.)
b.	If the required return is 11 percent, what is the project's NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to two decimal places, e.g., 1,234,567.89.)

    

Answer 1

Time line		0	1	2	3
Cost of new machine		-2350000
Initial working capital		-320000
=Initial Investment outlay		-2670000
3 years MACR rate			33.33%	44.45%	14.81%	7.41%
Sales			1745000	1745000	1745000
Profits	Sales-variable cost		1097000	1097000	1097000
-Depreciation	=Cost of machine*MACR%		-783255	-1044575	-348035	174135	=Salvage Value
=Pretax cash flows			313745	52425	748965
-taxes	=(Pretax cash flows)*(1-tax)		244721.1	40891.5	584192.7
+Depreciation			783255	1044575	348035
=after tax operating cash flow			1027976.10	1085466.50	932227.7
reversal of working capital					320000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				222300
+Tax shield on salvage book value	=Salvage value * tax rate				38309.7
=Terminal year after tax cash flows					580609.7
a. Total Cash flow for the period		-2670000	1027976.1	1085466.5	1512837
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631
Discounted CF=	Cashflow/discount factor	-2670000	926104.59	880988.96	1106173.7
b. NPV=	Sum of discounted CF=	243267.22