Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.27 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life. The project is estimated to generate $1,800,000 in annual sales, with costs of $710,000. The project requires an initial investment in net working capital of $430,000, and the fixed asset will have a market value of $450,000 at the end of the project.

a.	If the tax rate is 23 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.)
b.	If the required return is 10 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Time line		0	1	2	3
Cost of new machine		-2270000
Initial working capital		-430000
=Initial Investment outlay		-2700000
						100.00%
Sales			1800000	1800000	1800000
Profits	Sales-variable cost		1090000	1090000	1090000
-Depreciation	Cost of equipment/no. of years		-756666.7	-756666.7	-756666.7	0	=Salvage Value
=Pretax cash flows			333333.33	333333.33	333333.33
-taxes	=(Pretax cash flows)*(1-tax)		256666.67	256666.67	256666.67
+Depreciation			756666.67	756666.67	756666.67
=after tax operating cash flow			1013333.33	1013333.33	1013333.3
reversal of working capital					430000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				346500
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					776500
a. Total Cash flow for the period		-2700000	1013333.3	1013333.3	1789833
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-2700000	921212.12	837465.56	1344728.3
b. NPV=	Sum of discounted CF=	403405.96