In: Finance
The TropicalFlowers Company is evaluating an asset that may increase sales by $120,000 every year for 4 years. There is no expected change in net operating working capital. The company's cost of capital is 6%. The proposed asset costs $400,000, will require $20,000 to modify for operations, and falls in the 3-year class MACRS for depreciation rates: .33, .45, .15, and .07 for years 1 through 4, respectively. At the end of the 4 years, it is expected that the asset may sell for $30,000. The company's tax rate is 21%. SHOW ALL WORK FOR FULL CREDIT.
a) What is the initial outlay for this project?
b) What are the operating cash flows in Years 1 through 4?
c) As part of the terminal cash flow in Year 4, what is the after-tax salvage value of the asset?
d) What is the net present value of this proposed asset investment? Should it be accepted or rejected?
Time line | 0 | 1 | 2 | 3 | 4 | |||
Cost of new machine | -420000 | |||||||
=a. Initial Investment outlay | -420000 | |||||||
3 years MACR rate | 33.00% | 45.00% | 15.00% | 7.00% | 0.00% | |||
Sales | 120000 | 120000 | 120000 | 120000 | ||||
Profits | Sales-variable cost | 120000 | 120000 | 120000 | 120000 | |||
-Depreciation | =Cost of machine*MACR% | -138600 | -189000 | -63000 | -29400 | 0 | =Salvage Value | |
=Pretax cash flows | -18600 | -69000 | 57000 | 90600 | ||||
-taxes | =(Pretax cash flows)*(1-tax) | -14694 | -54510 | 45030 | 71574 | |||
+Depreciation | 138600 | 189000 | 63000 | 29400 | ||||
=b. after tax operating cash flow | 123906 | 134490 | 108030 | 100974 | ||||
+Proceeds from sale of equipment after tax | =selling price* ( 1 -tax rate) | 23700 | ||||||
+Tax shield on salvage book value | =Salvage value * tax rate | 0 | ||||||
=c. Terminal year after tax cash flows | 23700.00 | |||||||
Total Cash flow for the period | -420000 | 123906 | 134490 | 108030 | 124674 | |||
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.06 | 1.1236 | 1.191016 | 1.26247696 | ||
Discounted CF= | Cashflow/discount factor | -420000 | 116892.4528 | 119695.6212 | 90704.07115 | 98753.48537 | ||
d. NPV= | Sum of discounted CF= | 6045.63 |
Accept as NPV is positive