In: Finance
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.)
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.