Question

White Mountain Packaging is considering a project that would last for 2 years. The project would involve an initial investment of 195,000 dollars for new equipment that would be sold for an expected price of 168,000 dollars at the end of the project in 2 years. The equipment would be depreciated to 27,000 dollars over 7 years using straight-line depreciation. In years 1 and 2, relevant annual revenue for the project is expected to be 170,000 dollars per year and relevant annual costs for the project are expected to be 47,000 dollars per year. The tax rate is 50 percent and the cost of capital for the project is 6.34 percent. What is the net present value of the project?

Answer 1

Time line		0	1	2
Cost of new machine		-195000
=Initial Investment outlay		-195000
					100,00%
Sales			170000	170000
Profits	Sales-variable cost	123000	123000
-Depreciation	(Cost of equipment-salvage value)/no. of years	-24000	-24000	147000	=Salvage Value
=Pretax cash flows			99000	99000
-taxes	=(Pretax cash flows)*(1-tax)	49500	49500
+Depreciation			24000	24000
=after tax operating cash flow			73500	73500
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)		84000
+Tax shield on salvage book value	=Salvage value * tax rate		73500
=Terminal year after tax cash flows				157500
Total Cash flow for the period		-195000	73500	231000
Discount factor=	(1+discount rate)^corresponding period	1	1,0634	1,13081956
Discounted CF=	Cashflow/discount factor	-195000	69117,92364	204276,6222
NPV=	Sum of discounted CF=	78394,55