Question

Fairfax Paint is evaluating a 2-year project that would involve buying equipment for 420,000 dollars that would be depreciated to 20,000 dollars over 2 years using straight-line depreciation. Cash flows from capital spending would be 0 dollars in year 1 and 26,000 dollars in year 2. To finance the project, Fairfax Paint would borrow 420,000 dollars. The firm would receive 420,000 dollars from the bank today and would pay the bank $0 in 1 year and 477,246 dollars in 2 years (consisting of an interest payment of 57,246 dollars and a principal payment of 420,000 dollars). Relevant annual revenues are expected to be 348,000 dollars in year 1 and 380,000 dollars in year 2. Relevant annual costs are expected to be 92,000 dollars in year 1 and 88,000 dollars in year 2. The tax rate is 50 percent. The cost of capital is 9.28 percent and the interest rate on the loan would be 6.6 percent. What is the net present value of the project?

Answer 1

Note & Assumption:

1) Financial interest is not relevant fo cash flow. However it is deducted from EBIT to calculate the tax.

2) Net working capital requirement / change is zero.

3) After tax salvage value of the machine is assumed to be 20000. There will not be any capital gain

Deprciation.

Initial Cost = 420000 and after 2 years value come to 20000

As per straight line method, Depriciation / year = (420000-20000)/2 = 200000

Interest Calculation

	Loan(Interest @ 6.6%)
	Amt at Beging	Initerest	Amt at the End
Year1	420000	27720	447720
Year2	447720	29550	477270

Cashflow & NPV calculation

	Year0	Year1	Year2
Annual Revenue	$                -	$ 3,48,000	$ 3,80,000
Cost		$     92,000	$     88,000
EBITDA		$ 2,56,000	$ 2,92,000
(-) Depriciation		$ 2,00,000	$ 2,00,000
EBIT		$     56,000	$     92,000
(-)Interest		$     27,720	$     29,550
EBT		$     28,280	$     62,450
Tax @ 50%		$     14,140	$     31,225
A. Opearational Cash Flow
EBIT	$                -	$     56,000	$     92,000
(-) Tax		$     14,140	$     31,225
(+) Depriciation		$ 2,00,000	$ 2,00,000
Total Operational Cashflow	$                -	$ 2,41,860	$ 2,60,775
B. Capital Expenditure
Initial Outlay	$ -4,20,000
Capital Spending		$              -	$   -26,000
Salvage (after Tax)	$                -	$              -	$     20,000
Total Capital Spending Cashflow	$ -4,20,000	$              -	$     -6,000
Total Net Working Capital Cash Flow	$                -	$              -	$              -
Total Project Cashflow	$ -4,20,000	$ 2,41,860	$ 2,54,775
Cost of Capital	9.28%
NPV=	$14,662.72

NPV function of Xcel is used with cost of capital of 9.28%