Question

Quad Enterprises is considering a new 3-year expansion project that requires an initial fixed asset investment of $1.836 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $142,800. The project requires an initial investment in net working capital of $204,000. The project is estimated to generate $1,632,000 in annual sales, with costs of $652,800.

The tax rate is 21 percent and the required return on the project is 11 percent.

What is the project's Year 0 net cash flow? What is the project's Year 1 net cash flow? What is the project's Year 2 net cash flow?

What is the project's Year 3 net cash flow? What is the NPV?

Answer 1

Initial Investment = $1,836,000
Useful Life = 3 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $1,836,000 / 3
Annual Depreciation = $612,000

Initial Investment in NWC = $204,000

Salvage Value = $142,800

After-tax Salvage Value = $142,800 * (1 - 0.21)
After-tax Salvage Value = $112,812

Annual Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = ($1,632,000 - $652,800) * (1 - 0.21) + 0.21 * $612,000
Annual Operating Cash Flow = $979,200 * 0.79 + 0.21 * $612,000
Annual Operating Cash Flow = $902,088

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,836,000 - $204,000
Net Cash Flows = -$2,040,000

Year 1:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $902,088

Year 2:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $902,088

Year 3:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $902,088 + $204,000 + $112,812
Net Cash Flows = $1,218,900

Required return = 11%

NPV = -$2,040,000 + $902,088/1.11 + $902,088/1.11^2 + $1,218,900/1.11^3
NPV = $396,095.92