Question

24.

Blue Eagle Banking is considering a project that would last for 3 years and have a cost of capital of 11.76 percent. The relevant level of net working capital for the project is expected to be 20,000 dollars immediately (at year 0); 6,000 dollars in 1 year; 29,000 dollars in 2 years; and 0 dollars in 3 years. Relevant expected operating cash flows and cash flows from capital spending in years 0, 1, 2, and 3 are presented in the following table. What is the net present value of this project?

	Time 0	Year 1	Year 2	Year 3
Operating cash flows (in dollars)	0	58,000	73,000	57,000
Cash flows from capital spending (in dollars)	-122,000	0	0	9,000

Answer 1

The Net Present Value of a Project is the difference between Present Value of Cash Inflows and Initial Cash Outflows. The present value of Cash inflow is computed by discounting cash flows at the cost of capital.

Computation of Cash Outflow

Initial Outflow = $122,000+20000=$142000

Cash Inflow = Present Value of Net future cash flows discounted at Cost of capital rate

Computation of Discounted Cash Flows
Year (n)	Cash Inflow (A)	Changes in Working Capital(B)	Net Cash flows 'C = A - B	Discounting Factor               D = 1/(1+.1176)^n	Discounted Cash flows
1	58,000	(14,000)	72,000	0.8948	64,425.60
2	73,000	23,000	50,000	0.8006	40,030.00
3	57,000	(29,000)	86,000	0.7164	61,610.40
Total					166,066

Changes in Working Capital
Year	Opening Working Capital	Closing Working Capital	Changes in Working Capital
0	0	20000	20,000
1	20000	6000	(14,000)
2	6000	29000	23,000
3	29000	0	(29,000)

Therefore NPV of the Project = $166,066- $ 142,000 = $24,066