Question

A retailer is looking to expand operations at all of their stores for an initial investment of $680. This investment will be depreciated on a straight line basis over the project's 8 year life. The expansion is expected to produce annual cash inflows of $530 in each year over the life of the project, while also producing annual cash outflows of $330 in each year over the life of the project. What is the project's NPV if the corporate tax rate is 38% and the project's required rate of return is 8%?

Answer 1

Annual depreciation=(Cost-Residual value)/Useful Life

=(680/8)

=$85/year

Annual operating cash flow=(Increase in annual cash inflows-Increase in annual cash outflows)(1-tax rate)+Tax savings on Annual depreciation

=(530-330)(1-0.38)+(0.38*85)

=$156.3

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=156.3/1.08+156.3/1.08^2+156.3/1.08^3+156.3/1.08^4+156.3/1.08^5+156.3/1.08^6+156.3/1.08^7+156.3/1.08^8

=$898.2

NPV=Present value of inflows-Present value of outflows  

=898.2-680

=$218.2(Approx)