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%

Answer 1

The NPV of the project is -$7708.7

EXPLANATIONS: -

A). Initial investment of the project at year 0 is $80,000

cash flow (year 0) = cost of new equipment + increase in Net working capital

1. cost of new fixed assets = $70,000

2.increase in Net working capital = $10,000

cash flow (year 0) = ($70,000+ $10,000) = $80,000

B). Yearly after-tax operating Cash Flow for each year is $25,066.55

Annual revenue	$56,000
Decrease in Expenses	($$30,000)
Depreciation ( $70,000 * .3333)	($23,333)
Earnings before tax	$2,667
Taxes (35%)	($933.45)
Earnings after tax	$1,733.55
Add non-cash expense (depreciation)	$23,333
Yearly operating Cash Flow	$25,066.55

C). Terminal cash flow of the project is $13,250

Terminal cashflow = NSV of project assets + Recovered Net working capital

1.NSV of project assets = market value of asset * (1- tax rate)

= $5,000 * (1-.35)

=$3,250

2.Recovered Net working capital = $10,000

Therefore, Terminal cashflow ==$3,250 + $10,000= $13,250

D. NPV CALCULATIONS: -

NPV = after-tax operating cashflows *(PVIFA. 10%,3 years) + Terminal cashflow * (PVIF.10%, year 3) - initial investment

NPV= ($25,066.55 * 2.487) + ($13,250 * 0.751) -$80,000

NPV=    $62,340.5 + $9,950.75 -$80,000

NPV = -$7708.7