Question

ABC Ltd is considering an investment of $210,000 in a project that will generate revenues of $400,000 at the end of the first year, $300,000 at the end of the second year and $600,000 at the end of the third year. The expenses of the project are as follows: $250,000 in the first year, $120,000 in the second year and $300,000 in the third year. Additional to the revenue and expenses Working Capital of $150,000 is needed throughout the project. The tax rate is 30%, and tax laws allow the investment to be depreciated over three years, even though the investment has a useful life of three years. Should ABC engage the investment with a required rate of return of 15% (assume all cash flows occur at the end of the year)? – Use both NPV and IRR calculations.

Answer 1

	Year		0	1	2	3
	Initial cost		-210000
	Increase in NWC/ Recovery of NWC		-150000			150000
	Revanue			400000	300000	600000
	Less: Expenses			250000	120000	300000
	Less: Depreciation	(210000/3)		70000	70000	70000
	PBT			80000	110000	230000
	Less: Tax @ 30%			24000	33000	69000
	PAT			56000	77000	161000
	Add: Depreciation			70000	70000	70000
	Operating cash flow			126000	147000	231000
	Net cash flows		-360000	126000	147000	381000
	PV factor @ 15%		1	0.86956522	0.756144	0.657516
	PV of NCF		-360000	109565.217	111153.1	250513.7
	NPV =	(Sum of PV of NCF)	111232
	Calculation of IRR =
	At IRR NPV =		0
	Rate			NPV
	29%			3493.08
	IRR			0.00
	30%			-2676.38
	IRR - 29/30-29 =		0-3493.08/(-2676.38-3493.08)
	IRR -29 =		-3493.08/-6169.46
	IRR -29 =		0.566189
	IRR =		29.56619
	the project has positive NPV and IRR is more then the required return; therefore the project is acceptable.