Question

Company AAA 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%.

(SHOW YOUR WORK. Correct answers with no formulas/calculations receive no credit)

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

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

c) Find Net Capital Spending (NCS) for each year, and the after tax cash flow from the sale of assets in year 4 (show your work/calculations).

d) Find the CFFA for each year (show your work/calculations).

e) Find the NPV of this project. (show your work/calculations).

f) Find the IRR of the project. (show your work/calculations).

g) Should you invest in the project and why?

Answer 1

1-	Year	1	2	3	4
	sales	240000	240000	240000	240000
	operating cost-35%	84000	84000	84000	84000
	depreciation =160000/4	40000	40000	40000	40000
	fixed cost	30000	30000	30000	30000
	operating profit	86000	86000	86000	86000
	less tax-20%	17200	17200	17200	17200
	after tax profit	68800	68800	68800	68800
	add depreciation	40000	40000	40000	40000
	operating cash flow	108800	108800	108800	108800
2-	Year	0	1	2	3	4
	Investment in working capital	-8000	0	0	0	8000
3-	Year	0	1	2	3	4
	purchase of equipment	-160000	0	0	0	0
	after tax sale proceeds of machine					16000
	net capital spending	-160000	0	0	0	16000
4-	year	0	1	2	3	4
	operating cash flow		108800	108800	108800	108800
	Investment in working capital	-8000				8000
	net capital spending	-160000				16000
	CFFA	-168000	108800	108800	108800	132800
5-	year	0	1	2	3	4
	CFFA	-168000	108801	108802	108803	132804
	present value factor at 10% =1/(1+r)^n r =10% n=1,2,3,4	1	0.909090909	0.826446281	0.751314801	0.683013455
	present value of CFFA = CFFA*present value factor at 10%	-168000	98910	89919.00826	81745.30428	90706.91893
	NPV =sum of present valueof cash flow	193281.23
6-	IRR =Using IRR function in MS excel	IRR(L2679:P2679)	54.87%
7-	yes machine should be purchased as it results in positive NPV and IRR is greater than required rate of return