Question

Please provide a step by step solution. Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $3.09 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2132664 in annual sales, with costs of $805848. If the tax rate is 34 percent and the required return on the project is 11 percent, what is the project's NPV?

Answer 1

To calculate the Net Present Value of the project, we’ll follow the following steps:

1. The initial investment is noted (year 0).

2. The sales and Cost values of each year are noted (years 1-3).

3. Profit before interest, depreciation, and taxes (PBDIT) is computed by subtracting the cost from sales.

4. The value of depreciation is calculated by dividing the initial investment by the useful life (3 years). It is subtracted from PBDIT to compute Profit before interest and taxes (PBIT)

3. From PBIT, the value of interest (zero here) is subtracted. This gives us Profit before tax (PBT)

4. Tax calculated @34% as given in the problem is deducted from PBT to compute Profit After Taxes (PAT).

5. Depreciation value of each year (except year 0) is added back to PAT as depreciation is a non-cash expense. The value comes out is called Net Cash Flow. The values are noted in a separate table.

6. The discount factors for each year is calculated by using the formula CF/(1+R)ⁿ. Where CF is the cash flow, R is Discount rate and n is the year.

7. Find the product of Net Cash Flow and discount factor to compute Discounted Cash Flow.

8. Add the Discounted Cash Flows of all the years (0-n) to compute NPV.

9. Accept the project if NPV Value is positive.