Question

Problem 10-12 NPV and Modified ACRS [LO1]

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.79 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,110,000 in annual sales, with costs of $799,000. The project requires an initial investment in net working capital of $330,000, and the fixed asset will have a market value of $225,000 at the end of the project.

  

If the tax rate is 35 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (MACRS schedule) (Enter your answers in dollars, not millions of dollars, e.g. 1,234,567. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.)

Years	Cash Flow
Year 0	$
Year 1	$
Year 2	$
Year 3	$

If the required return is 12 percent, what is the project's NPV? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)

NPV

$

Answer 1

The cash flows for each year are calculated below:

Year	Initial investment	Sales	Cost	Depreciation	Income before tax	Tax	Income after tax	Cash flows
0	3120000							-3120000
1		2110000	799000	929907	381093	133382.6	247710.45	1177617.45
2		2110000	799000	1240155	70845	24795.75	46049.25	1286204.25
3		2110000	799000	413199	897801	314230.4	583570.65	1215378.3
Total	3120000	6330000	2397000	2583261	1349739	472408.7	877330.35	559200

Notes:

1. Cash flows = Income after tax + Depreciation

2. Cash flows for year 3 also includes after tax salvage value

Profit of sale of fixed asset = $225000 - ($2790000-$2583261) = $18261

Tax of gain = 35% * $18261 = $6391.35

After tax salvage value = $225000 - $6391.35 = $218608.65

The present value is as below:

Year	Cash flows	PV factor	Present Value
0	-3120000	1	-3120000
1	1177617.45	0.892857	1051444.15
2	1286204.25	0.797194	1025354.15
3	1215378.3	0.71178	865082.27
NPV			-178119.43