Question

H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,350,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,290,000 in annual sales, with costs of $1,310,000. Assume the tax rate is 21 percent and the required return on the project is 10 percent.

What is the project’s NPV?

Answer 1

Time line		0	1	2	3
Cost of new machine		-2350000
=Initial Investment outlay		-2350000
						100.00%
Sales			2290000	2290000	2290000
Profits	Sales-variable cost		980000	980000	980000
-Depreciation	Cost of equipment/no. of years		-783333.3	-783333.3	-783333.3	0	=Salvage Value
=Pretax cash flows			196666.67	196666.67	196666.67
-taxes	=(Pretax cash flows)*(1-tax)		155366.67	155366.67	155366.67
+Depreciation			783333.33	783333.33	783333.33
=after tax operating cash flow			938700.00	938700.00	938700
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					0
Total Cash flow for the period		-2350000	938700	938700	938700
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-2350000	853363.64	775785.12	705259.2
NPV=	Sum of discounted CF=	-15592.04