Question

3. XYZ Co. is considering a new investment in a project whose data are shown below. The equipment would be fully depreciated on a straight-line basis over the project's 3-year life and would require additional net operating working capital that would be recovered at the end of the project's life. The company owns the building where this equipment will be operational. The company curently has an offer from a competitor to buy said building for $100,000 from XYZ if it decides not to acquire the equipment and move forward with the project. Revenues and other operating costs are expected to be constant over the project's life. What is the initial investment the company must make in Year 0? WACC Net investment in fixed assets (depreciable basis) Required net operating working capital adjustments Straight-line depreciation rate Annual sales revenues Annual operating costs (excl. depr.) Tax rate 12% $200,000 $50,000 33.333% $150,000 $115,000 21%

Answer 1

Operating cash flow (OCF) each year = earnings after tax + depreciation.

The equipment is fully depreciated by end of Year 3, hence its book value is zero.

NPV is calculated using NPV function in Excel.NPV(12%,c24:e24)+b24

NPV is $-7518295.599

Initial Investment	0	1	2	3
Cost of equipment	200000
investment in working capital	50000
OCF
Revenues		150000	150000	150000
Less: operating costs		115000	115000	115000
Less: depreciation		16666.67	16666.67	16666.67
Earning before tax		18333.33	18333.33	18333.33
Less: taxes		3850	3850	3850
EAT		14483.33	14483.33	14483.33
Add: depreciation		16666.67	16666.67	16666.67
OCF		31150	31150	31150
Terminal cash flow
Salvage value				100000
tax				21000
salvage value after tax				79000
recovery of working capital				50000
terminal cash flow				29000
NPV analysis
Projected cash flows	-150000	31150	31150	60150
NPV	-7518295.599%