Question

Silver Sun Packaging is evaluating the vending machine project, a 2-year project that would involve buying equipment for 24,000 dollars that would be depreciated to zero over 2 years using straight-line depreciation. Cash flows from capital spending would be $0 in year 1 and 13,000 dollars in year 2. Relevant annual revenues are expected to be 61,000 dollars in year 1 and 61,000 dollars in year 2. Relevant expected annual variable costs from the project are expected to be 11,000 dollars in year 1 and 11,000 dollars in year 2. Finally, the firm has no fixed costs in year 1 and one fixed cost in year 2 of the project. Yesterday, Silver Sun Packaging signed a deal with Orange Valley Marketing to develop an advertising campaign. The terms of the deal require Silver Sun Packaging to pay Orange Valley Marketing either 65,000 dollars in 2 years from today if the vending machine project is pursued or 44,000 dollars in 2 years from today if the vending machine project is not pursued. The tax rate is 20 percent and the cost of capital for the vending machine project is 9.56 percent. What is the net present value of the vending machine project?

Answer 1

Calculation of net present value of the vending machine project
Year	0	1	2
Cash flows from capital spending	-$24,000	$0	$13,000
Operating Cash flow		$42,400	$25,600
Net Cash flow	-$24,000	$42,400	$38,600
x Discount Factor @ 9.56%	1.00000	0.91274	0.83310
Present Value	-$24,000	$38,700	$32,158
Net Present value of vending machine project	$46,858
Note : It is assumed that cash flow from capital spending in Year 2 is after tax cash flow.
Working
Calculation of operating cash flow
Year	1	2
Revenue	$61,000.00	$61,000.00
Less : Variable Costs	$11,000.00	$11,000.00
Less : Depreciation	$12,000.00	$12,000.00
Less : Marketing Cost [$65000 - $44000]	$0.00	$21,000.00
Profit before tax	$38,000.00	$17,000.00
Less : Tax @ 20%	$7,600.00	$3,400.00
Add : Depreciation	$12,000.00	$12,000.00
Operating Cash flow	$42,400.00	$25,600.00