Question

Sway's Back Store is considering a project which will require the purchase of $1 million in new equipment. The equipment will be depreciated straight-line to $200,000 over the 5-year life of the project. The first-year sale from this project is estimated at $800,000, then it keeps growing at a 5% rate. The variable cost is always 50% of the annual sales and there is an annual fixed cost of $100,000. Sway's Back Store will sell the equipment at the end of the project at a market value of $240,000. The net working capital for the project equals to 10% of sales across years. All of the net working capital will be recouped at the end of the project. The firm desires a minimal 10% rate of return on this project. The tax rate is 40%. Please calculate the NPV for this project

Answer 1

The sales revenue expected from the  project, working capital requirement and variable costs for each year is shown in the following table :-

In the following table, the after tax cash flows from year 1-5 is calculated

Year	Before tax cash flows ($)	Variable expenses($)	Fixed expenses($)	Depreciation expense($)	Taxable income($)	Taxes ($)@40%	After tax cash flows
0	-1,000,000						-1,000,000
1	800000	400000	100000	200000	800000-400000-100000-200000= 100000	100000 x 0.40 = 40000	100000 -40000 + 200000= 260000
2	840000	420000	100000	200000	840000-420000-100000-200000= 120000	120000 x 0.40 =48000	120000-48000+200000= 272000
3	882000	441000	100000	200000	882000-441000-100000-200000= 141000	141000 x 0.40 =56400	141000-56400+200000= 284600
4	926100	463050	100000	200000	926100-463050-100000-200000= 163050	163050 x 0.40 =65220	163050-65220+200000= 297830
5	972405	486202.5	100000	200000	972405-486202.5-100000-200000=186202.5	186202.5 x 0.40 = 74481	186202.5-74481+200000= 311721.5

The terminal cash flow associated with the project = Proceeds from sale of assets - Taxes on sale of assets + Recovery of working capital

Terminal cash flow associated with the project = $ 240000 - 0.40 x $ 240000 + $ 442050.5 = $ 586,050.5

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NPV of the project = $ 435,849