Question

Ross Corporation is thinking of opening a new warehouse. The new equipment required has a net cost (depreciable basis) of €125,000. In addition, the company owns the building that would be used, and it could sell it for €130,000 after taxes if it decides not to open the new warehouse. The equipment for the project would be depreciated by the straight-line method over the project's 4-year life, after which it would be worth nothing and thus it would have a zero-salvage value. No new working capital would be required, and sales revenues (€160,000) and other operating costs (€50,000) would be constant over the project's 4-year life. The project’s cost of capital is 12%, and the tax rate is 35%. Based on Ross Corporation data, answer the questions

What is the annual cash flow of the project for years 1 to 4?

What is the project’s NPV (no decimal, no rounding)?

What is the project’s pay-back period (two decimals, no rounding)?

Answer 1

Tax rate		35%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4		Total
Cost		$           125,000	$          125,000	$           125,000	$           125,000
Dep Rate		25.00%	25.00%	25.00%	25.00%
Depreciation	Cost * Dep rate	$             31,250	$             31,250	$             31,250	$             31,250		$           125,000
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4
Sale		$           160,000	$          160,000	$           160,000	$           160,000
Less: Operating Cost		$             50,000	$             50,000	$             50,000	$             50,000
Contribution		$           110,000	$          110,000	$           110,000	$           110,000
Less: Depreciation		$             31,250	$             31,250	$             31,250	$             31,250
Profit before tax (PBT)		$             78,750	$            78,750	$             78,750	$             78,750
Tax@35%	PBT*Tax rate	$             27,563	$             27,563	$             27,563	$             27,563
Profit After Tax (PAT)	PBT - Tax	$             51,188	$            51,188	$             51,188	$             51,188
Add Depreciation	PAT + Dep	$             31,250	$             31,250	$             31,250	$             31,250
Cash Profit after-tax		$             82,438	$            82,438	$             82,438	$             82,438
Calculation of NPV
						12.00%
Year		Capital	Building	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$          (125,000)	$         (130,000)		$          (255,000)	1.0000	$    (255,000.00)
1				$             82,438	$             82,438	0.8929	$        73,604.91
2				$             82,438	$             82,438	0.7972	$        65,718.67
3				$             82,438	$             82,438	0.7118	$        58,677.38
4				$             82,438	$             82,438	0.6355	$        52,390.52
					Net Present Value	$        (4,608.51)
Calculation of payback period
Year					Annual Cash flow	Cumulative cash flows
0					$    (255,000.00)	$   (255,000.00)
1					$        82,437.50	$   (172,562.50)
2					$        82,437.50	$      (90,125.00)
3					$        82,437.50	$        (7,687.50)
4					$        82,437.50	$       74,750.00
		So payback period will lie in 4th year
		Payback period	=3+(7687.50/82437.50)
		Year	3.09