Question

HMS Corporation is considering an expansion project that requires investment in capital assets of $545,000, costs of $15,000 to modify the assets before they can be put into operation, and additional raw materials inventory of $50,000 to support the project. In addition, HMS had spent $25,000 to study the viability of this project. The one-time after-tax opportunity costs associated with this project are $36,000. The project is expected to generate operating revenue of $600,000 per year, and the associated operating expenses are estimated at $275,000 per year. The capital assets belong to asset class 9, which has a CCA rate of 30 percent. The assets are expected to sell for $42,000 when the project terminates in eight years. Assume the asset class remains open after the project terminates. The firm’s cost of capital is 14 percent and marginal tax rate is 40 percent. a) What is the initial after-tax cash flow? b) What is the present value of the CCA tax savings? c) What is the present value of the after-tax operating cash flows? d) What is the ending after-tax cash flow? e) What is the NPV of the project?

Answer 1

a)$6,46,000

b)$1,39,333.79

c)$9,04,578.46

d)$32,251.43

e)$4,30,163.68

Workings:

a)

Particulars	Amount
Investment in capital assets	5,45,000.00
Opportunity Cost	36,000.00
Additional raw material inventory	50,000.00
Cost to modify asset	15,000.00
Initial after-tax cash flow	6,46,000.00

b)

Initial Cash flow outflow	= investment in capital assets+Cost to modify asset
	=545000+15000
	=560000
PV of CCA tax savings	=(((560000*0.4*0.3)/(0.14+0.3))*((1.07/1.14)))-(((42000*0.4*0.3)/(0.14+0.3))*((1/(1.14)^8)))
	=143349.28-4015.49
	=139333.79

c)

Present value of the after-tax operating cash flows	=(operating revenue-operating expense)*(1-tax rate)*PVAF(14%,8)
	=(600000-275000)*60%*4.6389
	=904578.46

d)

Ending after-tax cash flow	=(Expected sale value+Raw material inventory)/(1.14^8)
	=(42000+50000)/(1.14^8)
	=32251.43

e)

NPV	= (PV of CCA tax savings+Present value of the after-tax operating cash flows+Ending after-tax cash flow)-Initial after-tax cash flow
	=(139333.79+904578.46+32251.43)-646000
	=430163.68