Question

Spirit Airlines is considering a new project. They have paid a market research firm $5,000 to evaluate viability of the potential investment. The company is expected to sell 80,000 units at $3 each, operating expenses equal to 35% of sales, and fixed cost equal to $30,000 every year. The plan for the company is to operate for 4 years. The company also needs to build its inventory, which requires an upfront investment of $8,000. To start its operations, the company bought today new equipment worth of $160,000, which will depreciate straight line over the next 4 years. At the end of the investment horizon you will be able to sell these assets for $20,000. Assume the tax rate is 20%, and that projects with similar risk have a required return (i.e., discount rate) of 10%.

Find the Operating Cash Flows for each year (show your work/calculations).

Find the change in net working capital (∆NWC) for each year (show your work/calculations).  

Answer 1

Operating Cash Flow for the year 1 - 4 is $108,800

Change in net working capital for year 0 is -$8,000

Change in net working capital for year 4 is $8,000

Calculation of NPV of the Project
Particulars	0	1	2	3	4
Initial Investment
Cost of new equipment	-160000
Investment in net working capital	-8000
Net Investment (A)	-168000
Operating Cash Flows
Annual Sales (B = 80000 * $3)		240000	240000	240000	240000
Operating Expenses (C = B*35%)		84000	84000	84000	84000
Fixed Costs (D)		30000	30000	30000	30000
Depreciation (E ) $160,000 / 4 years		40000	40000	40000	40000
Profit Before Tax (F = B-C-D-E)		86000	86000	86000	86000
Tax @20% (G = F*20%)		17200	17200	17200	17200
Profit After Tax (H = F-G)		68800	68800	68800	68800
Add back Depreciaiton (I = E)		40000	40000	40000	40000
Net Operating Cash Flows (J = H+I)		108800	108800	108800	108800
Terminal Value
Sale Value (K)					20000
Tax @20% (L = K*20%)					4000
After tax sale value (M = K-L)					16000
Recovery of net working capital (N)					8000
Net Terminal Value (O = M+N)					24000
Total Cash Flows (P = A+J+O)	-168000	108800	108800	108800	132800
Discount Factor @10% (Q) 1/(1+10%)^n n=0,1,2,3,4	1	0.909090909	0.826446281	0.751314801	0.683013455
Discounted Cash Flows (R = P*Q)	-168000	98909.09091	89917.35537	81743.05034	90704.18687
NPV	193273.6835