Question

Mandelker Corp. forecasts that a new lathe will enable them to increase sales by $800,000 at a cost of $540,000 per year for the next 3 years. The press will cost $600,000 and will be depreciated, using straight-line depreciation, over 3 years down to a value of zero. The project requires an initial increase in net working capital of $40,000 that will be recovered in the terminal year. The firm will also be able to sell the lathe for $90,000 after the project is over. The firm’s marginal tax rate is 40%. The required return is 15%.

a. What is the firm’s cash flow in year 0?
-290,000
-440,000
-600,000
-640,000
none of the above

b. What is the firm’s Operating Cash Flow in year 2?
350,000
236,000
150,000
297,500
290,000

c. What is the NPV of the project?

39,352
87,977
83,942
36,357
104,025

Answer 1

1)

Cash flow in year 0 = Cost + increase in NWC

Cash flow in year 0 = -600,000 + -40,000

Cash flow in year 0 = -640,000

2)

Annual cash flow =600,000 / 3 = 200,000

Cash flow in year 2 = (Sales - costs - depreciation)(1 - tax) + depreciation

Cash flow in year 2 = (800,000 - 540,000 - 200,000)(1 - 0.4) + 200,000

Cash flow in year 2 = 36,000 + 200,000

Cash flow in year 2 = 236,000

3)

Cash flow in year 1 = 236,000

Cash flow in year 2 = 236,000

Non operating year 3 cash flow = Market value + NWC - tax(market value - book value)

Non operating year 3 cash flow = 90,000 + 40,000 - 0.4(900,000 - 0)

Non operating year 3 cash flow = 90,000 + 40,000 - 36,000

Non operating year 3 cash flow = 94,000

Year 3 cash flow = 94,000 + 236,000

Year 3 cash flow = 330,000

NPV = Present value of cash inflows - present value of cash outflows

NPV = -640,000 + 236,000 / (1 + 0.15)¹ + 236,000 / (1 + 0.15)² + 330,000 / (1 + 0.15)³

NPV = $39,352