Question

A firm is considering a project that requires no new purchases of equipment. Instead, they will repurpose existing machines that they already own. These machines were originally bought for $1 million 10 years ago and were depreciated straight line over that period to a book value of $0 today. Their market value is estimated to be $65,000. The machines require no investment in repairs or refurbishment for the new project. The new project is expected to generate revenues of $90,000 per year for four years. Operating expenses will be 72% of revenues. The project requires an initial investment in working capital of $2,000. Further investments in working capital will be needed as follows: an additional $1,000 at t=1, $1,500 at t=2, and $3,000 at t=3. It is assumed that all of the investments in working capital made over t=0,1,2,3 will be completely recovered at the end of the project. The corporate tax rate is 34%. At t=4, the market value of the equipment is expected to be $25,000 when the company plans to liquidate the equipment. If the cost of capital is 12.75%, should the investment be undertaken?

	0	1	2	3	4

Answer 1

since npv is positive we should take the investment