Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.88 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,140,000 in annual sales, with costs of $823,000. The project requires an initial investment in net working capital of $360,000, and the fixed asset will have a market value of $240,000 at the end of the project.

a.	If the tax rate is 21 percent, what is the project’s Year 1 net cash flow? Year 2? Year 3? Table 8.3. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)
b.	If the required return is 10 percent, what is the project's NPV? (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

Initial Investment = $2,880,000
Useful Life = 3 years

Depreciation Year 1 = 33.33% * $2,880,000
Depreciation Year 1 = $959,904

Depreciation Year 2 = 44.45% * $2,880,000
Depreciation Year 2 = $1,280,160

Depreciation Year 3 = 14.81% * $2,880,000
Depreciation Year 3 = $426,528

Book Value at the end of Year 3 = $2,880,000 - $959,904 - $1,280,160 - $426,528
Book Value at the end of Year 3 = $213,408

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $240,000 - ($240,000 - $213,408) * 0.21
After-tax Salvage Value = $234,415.68

Initial Investment in NWC = $360,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$2,880,000 - $360,000
Net Cash Flows = -$3,240,000

Year 1:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($2,140,000 - $823,000) * (1 - 0.21) + 0.21 * $959,904
Operating Cash Flow = $1,242,009.84

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,242,009.84

Year 2:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($2,140,000 - $823,000) * (1 - 0.21) + 0.21 * $1,280,160
Operating Cash Flow = $1,309,263.60

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,309,263.60

Year 3:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($2,140,000 - $823,000) * (1 - 0.21) + 0.21 * $426,528
Operating Cash Flow = $1,130,000.88

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $1,130,000.88 + $360,000 + $234,415.68
Net Cash Flows = $1,724,416.56

Answer b.

Required Return = 10%

NPV = -$3,240,000 + $1,242,009.84/1.10 + $1,309,263.60/1.10^2 + $1,724,416.56/1.10^3
NPV = $266,715.57