Question

1. Blue Ribbon, Inc., is considering a new two-year expansion project that requires an initial fixed asset investment of $3 million. The fixed asset actually falls into the three-year MARCRS class (as shown in the Table below). Suppose that at the end of the project, the fixed asset will have a market value of $2 million. The project is estimated to generate $4 million in annual sales, with costs of $2 million. The project also requires an initial investment in net working capital of $500,000 and the investment in net working capital will be fully recovered at the end of the project. If the tax rate of the firm is 21% and the required return on the project is 15%, what is the project’s NPV? Should the firm accept this project?

Modified ACRS (MACRS) Depreciation Schedule

Year	Property Class Three-Year
1	33.33%
2	44.45
3	14.81
4	7.41
Sum	100%

Answer 1

	Note 1
	Computation of MARC depreciation	1	2	3
	Depreciation rate		33.33%	44.45%	14.81%
	Depreciation amount		999,900	1,333,500	444,300
	Note 2
	Computation of post tax salvage value
	Sales price of asset =		2,000,000
	book value =		222,300
	Gain on sales		1,777,700
	Tax on gain		373,317
	Post tax salvage value=		1,626,683
	year	0	1	2	3
	Initial investment	(3,000,000)
	Working capital	(500,000)			500,000
	Operating cash flow
	Incremental contribution margin	2,000,000	2,000,000	2,000,000
	depreciation		999,900.00	1,333,500.00	444,300.00
	Profit before tax		1,000,100.00	666,500.00	1,555,700.00
	Tax @ 21%		210,021.00	139,965.00	326,697.00
	Net income		790,079.00	526,535.00	1,229,003.00
	Operating cash flow		1,789,979.00	1,860,035.00	1,673,303.00
	Post tax salvage value
	Note -2				1,626,683
	Net cash flow	(3,500,000.00)	1,789,979.00	1,860,035.00	3,799,986.00	-
	PVIF @ 15%	1	0.8696	0.7561	0.6575
	Present value	(3,500,000.00)	1,556,503.48	1,406,453.69	2,498,552.48	1,961,509.64
	NPV =	1,961,509.64
	Since NPV is positive, project should be accepted