Question

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.56 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life and is estimated to have a market value of $224568 at the end of the project. The project is estimated to generate $2163352 in annual sales, with costs of $830575. The project requires an initial investment in net working capital of $385937. If the tax rate is 31 percent and the required return on the project is 9 percent, what is the project's NPV?

Answer 1

Initial Investment = Cost of asset + net working capital = $2,560,000 + $385,937 = $2,945,937

Annual cash flows

Sales	$2,163,352
Less: Costs	$830,575
Less: Depreciation [ $2,560,000 / 3 ]	$853,333.33333
Earnings before tax	$479,443.66667
Less: Tax @31%	$148,627.53667
Net Income	$330,816.13
Add: Depreciation	$853,333.33333
Cash Flows per year	$1,184,149.46333

After tax salvage value of asset = $224,568 x (1 - 0.31) = $154,951.92

NPV = (-)Initial Investment + Annual cash flows x PVIFA (9%, 3) + After tax salvage value of asset x PVIF (9%, 3) + Working capital recovered x PVIF (9%, 3)

or, NPV = (-)$2,945,937 + $1,184,149.46333 x 2.53129466597 + $154,951.92 x 0.77218348005 + $385,937 x 0.77218348005 = $469,159.70879 or $469,159.71

Note :

PVIF = 1 / (1 + r)ⁿ

Also, I assumed that the working capital will be recovered in the final year (year 3) as nothing was mentioned regarding the same. If you get an incorrect answer, try removing working capital recovered and then compute the NPV.