Question

White Mountain Consulting is considering a project that would last for 2 years and have a cost of capital of 17.72 percent. The relevant level of net working capital for the project is expected to be 21,000 dollars immediately (at year 0); 32,000 dollars in 1 year; and 0 dollars in 2 years. Relevant expected revenue, costs, depreciation, and cash flows from capital spending in years 0, 1, and 2 are presented in the following table (in dollars). The tax rate is 50 percent. What is the net present value of this project?

	Year 0	Year 1	Year 2
Revenue	$0	220,000	220,000
Costs	$0	64,000	64,000
Depreciation	$0	35,000	35,000
Cash flows from capital spending	-73,000	0	10,000

Answer 1

Answer: NPV of this project is 69786.75

EXPLANATION:

Relevant cash flows in a given year = OCF + CF effects from ΔNet Working Capital (ΔNWC) + CF from capital spending + terminal value

In this problem, terminal value = 0

Therefore, relevant cash flows in a given year = OCF + CF effects from ΔNWC + CF from capital spending. We are given CF from capital spending. We can compute OCF from revenue, costs, depreciation, and the tax rate. We are given NWC for each point in time (years 0, 1, 2, and 3) and must compute ΔNWC as NWC at the end of a period minus NWC at the start of the period and the cash flow effects from ΔNWC as –ΔNWC.

The calculation discounted cash flows is as follows:-

Discounted cash flow calculation

Year	0	1	2
Operating cashflow (OFC)
Revenue		220,000	220,000
costs		64,000	64,000
Depreciation		35,000	35,000
EBIT = revenues – costs – depreciation		121000	121000
tax rate		.5	.5
Taxes = tax rate × EBIT		60500	60500
net income		60500	60500
OCF = net income + depreciation		95500	95500
Net working capital (NWC)	21000	32000	0
ΔNWC = NWC at end of period minus NWC at start of period	21000	32k-21k =11000	0-32k =32000
Cash flow effects from ΔNWC	-21000	-11000	32000
Cash flows from capital spending	-73,000	0	10000
Total cashflows	-94000	84500	127500
PV of $1 Factor for 17.72%	1	.8495	.7216
Discounted cashflows	-94000	71782.75	92004

NPV = PV of future expected cashflows – initial investment

PV of future expected cashflows = (71782.75 + 92004) = 163786.75

Initial investment = 94000

NPV = 163786.75 - 94000

NPV of the project= 69786.75