Slick Company is considering a capital project involving a $225,000 investment in machinery and a $45,000...

Slick Company is considering a capital project involving a $225,000 investment in machinery and a $45,000 investment in working capital. The machine has an expected useful life of 10 years and no salvage value. The annual cash inflows (before taxes) are estimated at $90,000 with annual cash outflows (before taxes) of $30,000. The company uses straight-line depreciation. Assume the federal income tax rate is 40%.

The company’s new accountant computed the net present value of the project using a minimum required rate of return of 16% (the company’s cost of capital). The accountant’s computations follow:

	Cash inflows		$ 90,000
	Cash outflows		30,000
	Net cash inflow		$ 60,000
	Present value factor at 16%		× 4.833
	Present value of net cash inflow		$289,980
	Initial cash outlay		225,000
	Net present value		$ 64,980

Required:

a. Are the accountant’s computations correct? If not, compute the correct net present value.

b. Is this capital project acceptable to the company? Why or why not?

Expert Solution

a) No, the accountant's computation is not correct.

Year	Cash outflow	Cash inflow	Cash flow (Before tax)	Cash flow (After tax)	NPV	Cummulative NPV
0	270000	0	-270000	-270000	-270000	-270000
1	30000	90000	60000	36000	31034.48	-238965.52
2	30000	90000	60000	36000	26753.86	-212211.66
3	30000	90000	60000	36000	23063.68	-189147.98
4	30000	90000	60000	36000	19882.48	-169265.50
5	30000	90000	60000	36000	17140.07	-152125.43
6	30000	90000	60000	36000	14775.92	-137349.51
7	30000	90000	60000	36000	12737.86	-124611.65
8	30000	90000	60000	36000	10980.92	-113630.73
9	30000	90000	60000	36000	9466.31	-104164.42
10	30000	135000	60000	81000	18361.37	-85803.05

Note:-

Initial outflow of 270000 includes 225,000 of machinery and 45,000 of working capital
There will be no taxation on initial cashflow of -270000
There will be no taxation on the recovery of the working capital at the end of 10th year.
Cash flow (After tax) at the end of 10th year includes 36000 and 45000(working capital)

Hence, Net present value is -$85803.05

(b) No, this capital project is not acceptable by the company since the NPV is in negative. Negative NPV denotes loss for the company.

jeff jeffy answered 1 month ago

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