Question

Thomson Media is considering some new equipment whose data are shown below. The equipment would be used for three years with straight-line depreciation, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC 10.0% Net investment in fixed assets (depreciable basis) $70,000 Required net operating working capital $10,000 Straight-line depreciation rate 33.333% Annual sales revenues $56,000 Annual operating costs (excl. depreciation) $30,000 Expected pre-tax salvage value $5,000 Tax rate 35.0%

options: -$7,707 -$6,089 -$6,166 -$7,246 -$7,631

Answer 1

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

profit on sale of fixed assets at end of year 3 = sale price - book value

The book value is zero as the fixed assets are fully depreciated.

after-tax salvage value = salvage value - tax on profit on sale of fixed assets   

Terminal cash flow = recovery of net working capital + after-tax salvage value

NPV is calculated using NPV function in Excel

NPV is -$7,707

(The difference of $1 is due to rounding)

NPV is -$7,707