Question

Henry Jones is the owner of True Adventure Vacations, Inc. He is considering the purchase of computer equipment that will facilitate airline and hotel accommodations. He paid a consultant a $20,000 fee to identify the best computer system and to identify the best computer system and to identify related costs of the project. The computer will cost $300,000. Installation will cost $20,000 and training of personnel will cost $10,000. He will incur $50,000 in advertising costs to kick off the new improved services that will feature worldwide accommodations. He projects that there will be a $200,000 increase in sales annually over the 5 year life of the project. Costs are 60% of sales. The computer has a five year useful life and a salvage value of $30,000. Jones will use straight line depreciation. Working capital investment is $10,000 and will be fully recovered at the termination of the project in five years.

1. What is the annual after-tax cash flow for this project over the next five years? The tax rate is 34%.
2. What is the NPV of the project if the discount rate is 12%?

Answer 1

1-
Cash outflow
cost of computer	-300000
installation charges	-20000
training cost	-10000
investment in working capital	-10000
advertising expense	-50000
Cash outflow	-390000
Annual after tax cash flow
annual increased sales	200000
less cost of sales-60%	120000
less depreciation=(320000-30000)/5	58000
operating profit/loss	22000
less taxes-34%	7480
after tax profit/loss	14520
add depreciation	58000
after tax cash flow year 1-4	72520
cash flow In year 5
after tax cash flow year 1-4	72520
recovery of working capital	10000
sale proceeds of scrap	30000
after tax cash flow year 5	112520
Year	after tax cash flow	present value factor =1/(1+r)^n r =12%	present value of cash flow = after tax cash flow*pVF
0	-390000	1	-390000
1	72520	0.892857143	64750
2	72520	0.797193878	57812.5
3	72520	0.711780248	51618.30357
4	72520	0.635518078	46087.77105
5	112520	0.567426856	63846.86981
NPV =sum of present value of cash flow			-105884.56