Question

A firm is considering a project that requires an initial investment of $300,000 in new equipment, which has a five-year life and a CCA rate of 30 percent. An initial investment in raw materials inventory of $50,000 is also required to support the project, which will rise to 15 percent of sales. The project will generate sales revenue of $400,000 in the first year, which will grow at 4 percent per year. Variable costs will be $220,000 for the first year, which will grow at 6 percent per year. The project’s fixed costs are $40,000 per year. The expected salvage value of the asset is $45,000 at the end of five years. The firm’s marginal tax rate is 40 percent and required return is 12.5 percent. Assume the asset class remains open after the project terminates.

1. What is the present value of the CCA tax savings?

2. What is the present value of the after-tax operating cash flow (Revenues, Variable Costs, and Fixed Costs)?

3. What is the present value of the change in net working capital?

4. What is the NPV of the project?

Answer 1

A). present value of the CCA tax savings is $64,090

years	1	2	3	4	5
depreciation (300,000/5)	60,000	60,000	60,000	60,000	60,000
CAA tax savings (30)(B)	$ 18,000.00	$        18,000.00	$      18,000.00	$      18,000.00	$      18,000.00
PVIF @12.5%	0.8888888	0.7901234	0.7023319	0.62429507	0.55492895
Present value	$ 16,000.00	$        14,222.22	$      12,641.97	$      11,237.31	$        9,988.72
Total PV =64,090

B). the present value of the after-tax operating cash flow (Revenues, Variable Costs, and Fixed Costs) is $309,074

year	1	2	3	4	5
anuual sales(5000*300)	$      400,000.00	$    416,000.00	$    432,640.00	$    449,945.60	$    467,943.42
Variable cost(5000*150)	$   (220,000.00)	$ (233,200.00)	$ (247,192.00)	$ (262,023.52)	$ (277,744.93)
fixed cost	$      (40,000.00)	$    (40,000.00)	$    (40,000.00)	$    (40,000.00)	$    (40,000.00)
operating income	$      140,000.00	$    142,800.00	$    145,448.00	$    147,922.08	$    150,198.49
Tax (40%)	$        56,000.00	$      57,120.00	$      58,179.20	$      59,168.83	$      60,079.40
after tax operating cash flow(A)	$        84,000.00	$      85,680.00	$      87,268.80	$      88,753.25	$      90,119.10
PVIF @12.5%	0.8888888	0.7901234	0.7023319	0.62429507	0.55492895
present value	$        74,666.66	$      67,697.77	$      61,291.66	$      55,408.22	$      50,009.70
Total present value = 309,074

C). present value of the change in net working capital is -$26705.59

years	0	1	2	3	4	5
working capital requirement		$        60,000.00	$      62,400.00	$      64,896.00	$      67,491.84	$      70,191.51
working capital flows	-50000	-10000	$      (2,400.00)	$      (2,496.00)	$      (2,595.84)	$      67,491.84
PVIF @12.5%	1	0.8888888	0.7901234	0.7023319	0.62429507	0.55492895
present value	-50000	-8888.888	-1896.29616	-1753.020422	-1620.570115	37453.1759
Total value=(26705.59)

NOTE: - In year 5 a working capital of amount 2699.67 is deployed and released therefore, it will compensate each other therefore there will not be any effect of additional Net working capital in year 5 cash flows.

D). NPV of the project if we end the project after 5 years is 61441.71

CALCULATIONS: -

Net cash flows from operations

years	1	2	3	4	5
after tax operating cash flow(A)	$    84,000.00	$    85,680.00	$    87,268.80	$    88,753.25	$    90,119.10
CAA tax savings (30%)(B)	$    18,000.00	$    18,000.00	$    18,000.00	$    18,000.00	$    18,000.00
net operating cash flows of each year (A=B)	$ 102,000.00	$ 103,680.00	$ 105,268.80	$ 106,753.25	$ 108,119.10

Year	0	1	2	3	4	5
initial fixed assets investment	-300,000
change in Net working capital	-50000	-10000	-2400	-2496	-2595.84	67491.84
Yearly operating Cash Flow		102,000	103,680	105,269	106,753	108,119
NSV of project assets(45000*(1-.4)						27000
Total cash flows	-350,000	92,000	101,280	102,773	104,157	202,611
PV of $1 Factor for 16%	1	0.8888888	0.7901234	0.7023319	0.62429507	0.55492895
Discounted Cash Flow	-350,000	81777.7696	80023.69795	72180.61589	65024.95632	112434.6738
sum of discounted cash flows from year 1 to 5 = 411441.71

NPV = PV of future expected net cash inflows – initial investment

Initial investment = (350,000)

NPV = 411441.71 - 350000

NPV = 61441.71