Question

H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,350,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,470,000 in annual sales, with costs of $1,490,000. The project requires an initial investment in net working capital of $162,000 and the fixed asset will have a market value of $197,000 at the end of the project. Assume that the tax rate is 24 percent and the required return on the project is 10 percent. a. What are the net cash flows of the project each year? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) b. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Initial investment = 2350000

Terminal year cash flow includes operating and non-operating cash flow. Non-operating cash flow are calculated as

Non-operating cash flow = Sales proceeds - Tax*(sales proceeds- Book value) + Net working capital investment

Net working capital investment is assumed to be recovered at the end of the project

Since the asset is depreciated to zero, its book value at the end will be 0.

Therefore, Terminal year non-operating cash flow = 197000 - 0.24*(197000-0) + 162000

=$311720