Question

Down Under Boomerang, Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $2.4 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $2,050,000 in annual sales, with costs of $950,000. The tax rate is 35% and the required return is 12 percent. Calculate the projects NPV and IRR.

Suppose that Down Under Boomerang is projected to grow at a rate of 4% after year 3. What is the value of the firm?

Answer 1

Initial investment=2400000

The cash flows looks as below

Now, NPV can be found with a function in EXCEL

=NPV(rate, Year1 to Year3 cashflows)-Initial investment

=NPV(12%,Year1 to Year 3 cashflows)-2400000

NPV=-$10,178

IRR(Values)

=IRR(Year0 to Year3 cashflows)

IRR=11.75% (<12%)

NPV is negative and IRR is lower than cost of capital, firm should avoid this project

2. If cash flows grow at 3% from Year4, then we have to calculate terminal for Year3

Year3 Terminal value=Year4 cashflow/(cost of capital-growth rate)

Terminal value=(995000*(1+4%))/(12%-4%)

Terminal value=12935000

Add this terminal value to Year3 cashflow

Value of the firm=NPV(rate, Year1 to Year3 cashflows)

Value of the firm=NPV(12%,Year1 to year3 cashflows)

Value of the firm=$11,596,699.62