Question

In: Finance

H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset...

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. The project is estimated to generate $2,470,000 in annual sales, with costs of $1,490,000. The project requires an initial investment in net working capital of $162,000 and the fixed asset will have a market value of $197,000 at the end of the project. Assume that the tax rate is 24 percent and the required return on the project is 10 percent. a. What are the net cash flows of the project each year? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) b. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Solutions

Expert Solution

Project’s Year 0, Year 1, Year 2 and Year 3 Cash Flow

          Years

Cash Flow

Year 0

-$2,512,000

Year 1

$932,800

Year 2

$932,800

Year 3

$1,244,520

Calculate of Annual Cash Flow

Particulars

Amount ($)

Annual Sales

2,470,000

Less: Costs

1,490,000

Less: Depreciation [$2,350,000 / 3 Years]

783,333

Net Income Before Tax

196,667

Less: Tax at 24%

47,200

Net Income After Tax

149,467

Add Back: Depreciation

783,333

Annual Cash Flow

932,800

Year 0 Cash outflow

Year 0 Cash outflow = Initial Investment + Working Capital

= -$2,350,000 - $162,000

= -$2,512,000

Year 1 Cash Flow = $932,800

Year 2 Cash Flow = $932,800

Year 3 Cash Flow

Year 3 Cash Flow = Annual cash flow + Working capital + After-tax market value

= $932,800 + $162,000 + [$197,000 x (1 – 0.24)]

= $932,800 + $162,000 + $149,720

= $1,244,520

Net Present Value (NPV) of the Project

Year

Annual cash flows ($)

Present Value Factor (PVF) at 10.00%

Present Value of annual cash flows ($)

[Annual cash flow x PVF]

1

932,800

0.909090909

848,000.00

2

932,800

0.826446281

770,909.09

3

1,244,520

0.751314801

935,026.30

TOTAL

2,553,935.39

Net Present Value (NPV) of the Project = Present Value of annual cash inflows – Initial Investment

= $2,553,935.39 - $2,512,000

= $41,935.39

Hence, the Net Present Value (NPV) of the Project will be $41,935.39

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.


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