Question

You are considering a 3-year project of which details are summarized below. Your required rate of return for capital budgeting purposes is 20 percent.

• Annual sales = 30,000 units
• Unit sales price = $5.00
• Variable costs = $2.00 per unit
• Annual fixed costs = $18,000
• Initial capital investment = $72,000, depreciated to zero over 3 years
• Initial investment in working capital = $20,000, fully recovered at the end of the project
• The tax rate is 25%

a. What is the project’s annual net income?

b. What is the project’s annual operating cash flow?

c. What is the project’s initial capital investment?

d. What is the project’s NPV?  

e. What is the project’s IRR?  

f. Should you accept this project? Why or why not?

Answer 1

a. What is the project’s annual net income?

$36000

b. What is the project’s annual operating cash flow?

$60000

c. What is the project’s initial capital investment?

$92000

d. What is the project’s NPV? =

72969.14

e. What is the project’s IRR?

56.35%

f. Accept the project since NPV is positive.

Workings

1	Sales	150000
	Variable cost	60000
	Fixed cost	18000
	Depreciation	24000
	EBT	48000
	Taxes	12000
	Net Income	36000
2	OCF=Net Income+Depreciation	60000
3	Initial outlay=Cost+working capital	-92000

Year	Cash flows
0	-92000
1	60000
2	60000
3	60000
4	80000
NPV	72969.14
IRR	56.35%