Question

Bush Boomerang, Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $2.1 million. The asset will be depreciated on a straight-line basis over its three-year life; the expected salvage value at the end of year 3 is $325,000. The project requires an initial investment in net working capital of $275,000. The project is expected to generate $1,900,000 in incremental annual sales, with $850,000 in incremental costs. If the firm’s marginal tax rate is 35% and its WACC is 15%, forecast the project’s total cash flow stream and determine the NPV. Interpret your answer in words.

Answer 1

initial investment 2100000+275000 = 2375000

depreciation per year = (2100000-325000)/3 = 1775000/3 = 591667

incremental sales = 1900000

incremental cost = 850000

incremental profits = 1900000-850000 = 1050000

taxable incremental profits = incremental profits - depreciation = 1050000 - 591667 = 458333

after tax profits = taxable incremental profits - tax = 458333 - (35*458333)/100 = 458333 - 160417 = 297916

cash inflows = after tax profits + depreciation = 297916 + 591667 = 889583

WACC can be taken as MARR, MARR = 15%

year 1 cash inflows = 889583

year 2 cash inflows = 889583

year 3 cash inflows = 889583 + 325000 (salvage value) = 1214583

calculation of NPV, NPV = PVCI-PVCO
year	cash inflows	pvf @ 15%	pvci
1	889583	0.870	773550.4
2	889583	0.756	672652.6
3	1214583	0.658	798608
		total	2244811
		cash outflows	2375000
		npv	-130189

INTERPRETATION

AS THE NET PRESENT VALUE AT 15% RATE IS NEGATIVE i.e. -$130189, BUSH BOOMERANG INC. SHOULD REJECT THE EXPANSION PROJECT.