ABC Corporation has hired you to evaluate a new FOUR year project for the firm. The...

ABC Corporation has hired you to evaluate a new FOUR year project for the firm. The project will require the purchase of a $757,000.00 work cell. Further, it will cost the firm $54,200.00 to get the work cell delivered and installed. The work cell will be straight-line depreciated to zero with a 20-year useful life. The project will require new employees to be trained at a cost of $60,500.00. The project will also use a piece of equipment the firm already owns. The equipment has been fully depreciated, but has a market value of $6,800.00. Finally, the firm will invest $11,700.00 in net working capital to ensure the project has sufficient resources to be successful. The project will generate annual sales of $918,000.00 with expenses estimated at 37.00% of sales. Net working capital will be held constant throughout the project. The tax rate is 37.00%. The work cell is estimated to have a market value of $487,000.00 at the end of the fourth year. The firm expects to reclaim 87.00% of the final NWC position. The cost of capital is 14.00%. What is the NPV the project if we end the project after 4 years?

Solutions

Expert Solution

Calculation of Net present value

Assumption :- In Given question, tax rate only mentioned. it is not provided whether it is applicable for capital gain on sale of old equipment or not. Therefore, the given question solved in both assumptions.

It is assumed that the Tax rate given i.s 37% is applicable for both operational revenue income and any capital gain /(loss). It means the same tax rate is used to compute the tax on capital gain and tax shield on capital loss if any.
However , for student extra clarification problem also solved not taxing any capital gain and not taking tax shield on capital loss.

Depreciation is calculated below :-

While computing the depreciation, all the costs which is incurred to put the asset in use is added to cost of the equipment. Therefore, in the given case installation costs also added to cost of work cell.

Depreciation = (Total Cost - Scrap value )/Estimated useful life

Depreciation = 757000+54200)/20 = $ 40,560

Step:- 1 Computation of Inital Project Cost :-

Sno.	Particulars	Amount (In $)
1	Work cell cost	7,57,000
2	Installation cost	54,200
3	Employees training cost	60,500
4	Net working Capital	11,700
5	Initial Project cost (A)	8,83,400

Step:- 2 Calculation net initial cash flow from the sale of old equipment

Sno.	Particulars	Amount (In $)
1	Equipment market value	6,800
2	Less:- Book value	-
3	Gain on Old equipment	6,800
4	Less :- Tax on Gain @ 37%	2,516
5	Net Cash flow after Tax	4,284

Step :- 3 Computation of Present value of cash ouflows

Sno.	Particulars	Amount (In $)
1	Initial Project cost (A)	8,83,400
2	Net Cash flow after Tax	4,284
	Initial net Cash outflow	8,79,116

Step :-4 Calculation of Net cash flows per year

1. Calculation of Net Cash inflows
Sno.	Particulars	Amount (In $)
1	Annual Sales	9,18,000
2	Depreciation	40,560
3	Expenses	3,39,660
4	EBT (1-2-3)	5,37,780
5	Tax (4*37%)	1,98,979
6	PAT (4-5)	3,38,801
7	Depreciation	40,560
8	Net Cash inflows (6+7)	3,79,361

Step :- 5 Calculation of net cash inflow from work cell and working capital

Sno.	Particulars	Amount in $	Amount in $
1	Market value at 4rth year end		4,87,000
2	Value as at 4rth year end (a-b)		6,48,960
	(a) Value of machine and installation	8,11,200
	(b) Depreciation for 4 Years	1,62,240
3	Capital Loss		-1,61,960
4	Capital shield @ 37% (3*37%)		59,925
5	Net Cash inflow due to work cell (1+4)		5,46,925
6	Working Capital	11,700
7	*Realised working capital (687%)**		10,179
8	Net cash inflow at the year end		5,57,104

Step :- 6 Calculation of Present value of Net cash inflows

Year	Particulars	Amount (In $) (A)	Present value factor @ 14%(B)	*Present value of cash flows (AB)**
1	Net Cash inflows	3,79,361	0.8772	3,32,773
2	Net Cash inflows	3,79,361	0.7695	2,91,906
3	Net Cash inflows	3,79,361	0.6750	2,56,058
4	Net Cash inflows	3,79,361	0.5921	2,24,612
4	Sale of Work cell	5,46,925	0.5921	3,23,824
4	Working Capital	10,179	0.5921	6,027

Total Present value of cash flows	14,35,200

Step :- 7 Net Present Value

Sno.	Particulars	Amount (In $)
1	Present value of cash inflows	14,35,200
2	Present value of cash ouflows	8,79,116
3	Net Present value (1-2)	5,56,084

Alternative if the tax is not applicable for capital gain and no tax shield on capital loss