Question

2 year project Capital required for P&E = $2500 in Y0

WC = $550 in Y1 and $600 in Y2. Total not incremental WC & required at beginning of the year

Salvage value of P&E at end of 2 years = $900

Depreciation in each of first 2 years = $1,000 Production is 1,000 units per year. Assume revenue & costs are all incurred at the end of each year

Price = $2 / unit in Y1 and increases at a rate of 20%

Operating costs in Y1 = $400, Y2 = $500

Company owns land on which to build a plant which has a book value of $300. The current market value is $300 but it is expected to rise at an annual rate of 5%. The land will be sold after 2 years. Company originally planned to start the project 2 years ago and spent $50 in planning, but shelved it. T

ax rate = 34% Cost of capital = 15%.

Determine if we should undertake the project.

You want to:

1) Analyze Do Project

2) Analyze Don't Do

3) Analyze incremental cash flow

Answer 1

Year	Revenue	Operating costs	Working Capital	Depriciation	Profit Before Tax	Tax(@34%)	Profit After Tax	Depreciation	Cash Flow	PV Factor(@15%)	PV of Cash Flow
1	2000	(400)	(550)	(1000)	50	(17)	33	1000	1033	0.870	898.71
2	2400	(500)	(50)	(1000)	850	(289+136)=(425)	425	1000	1425+900=2325	0.756	1757.7
										TOTAL	2656.41

Year 1 revenue = 1000*2 = $2000

Year 1 revenue = 1000*(2.4) = $2400 (20% increase in price)

Tax on profit on sale of P&E = 900(sale) - 500(Book Value)=400(profit)*(0.34)=$136

Working Capital is total, therefore , for year 2, WC=600-550= $50

$900 salvage value is added to the cash flow.

$300 value of land is an asset and it is not a determinant for the taking up of the project as the company already owns the land and has not bought it for the purpose of the project.

The $50 spent 2 years back would have been taken into account (P&L account) because it has already been shelved.

The initial investment is $2500

PV of future cash flows from the project = $2656.41

Therefore, NPV of the project is $156.41.

The incremental cash flow in year 1 is $1033 (PV=$898.71) and in year 2 it is $2325(PV=$1757.7)

If we don't do the project then we would get $300 in year 0.

If we do it then,

Year	Value	PV Factor @ 15%	PV
1	300*(1.05)=315	0.870	274.05
2	315*(1.05)=330.75	0.756	250.047

The land will be sold at $330.75 after 2 years, which at year 0 has a value of $250.047. Adding to this the NPV of the project undertaken,i.e, $156.41. Total equals $406.457.

It is better to take up the project than selling off the land because if the project is taken there would be a benfit of $106.457(406.457-300).

Note: Brackets indicate negative number or subtraction.