Question

The Freeman Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 40 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project.

	Year 0		Year 1		Year 2		Year 3		Year 4
Investment	$	26,000
Sales revenue			$	13,500	$	14,000	$	14,500	$	11,500
Operating costs				2,900		3,000		3,100		2,300
Depreciation				6,500		6,500		6,500		6,500
Net working capital spending		320		370		420		320		?

a. Compute the incremental net income of the investment for each year. (Do not round intermediate calculations.)

	Year 1	Year 2	Year 3	Year 4
Net income	$	$	$	$

b. Compute the incremental cash flows of the investment for each year. (Do not round intermediate calculations. A negative answer should be indicated by a minus sign.)

	Year 0	Year 1	Year 2	Year 3	Year 4
Cash flow	$	$	$	$	$

c. Suppose the appropriate discount rate is 11 percent. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
  
NPV           $

Answer 1

a)

	Year 1	Year 2	Year 3	Year 4
Sales revenue	$13,500	$14,000	$14,500	$11,500
Operating cost	$2,900	$3,000	$3,100	$2,300
Depreciation	$6,500	$6,500	$6,500	$6,500
Income before taxes	$4,100	$4,500	$4,900	$2,700
Taxes(40%)	$1,640 ($4,100 ×40%)	$1,800 ($4,500 ×40%)	$1,960 ($4,900 ×40%)	$1,080 ($2,700 ×40%)
Net income	$2,460	$2,700	$2,940	$1,620

b)

	Year 0	Year 1	Year 2	Year 3	Year 4
Net income	-	$2,460	$2,700	$2,940	$1,620
Depreciation	-	$6,500	$6,500	$6,500	$6,500
OCF	-	$8,960	$9,200	$9,440	$8,120
Investments	($26,000)	0	0	0	0
Net working capital	($320)	($370)	($420)	($320)	$1,430
Incremental cash flow	($26,320)	$8,590	$8,780	$9,120	$9,550

Note:- $1,430 = $320 + $370 +$420 +320

c)

NPV = $1,504.07

Calculation:-

Years	Incremental cash flow	Discount factor(11%)
Year 1	$8,590	0.9009	$7,738.73
Year 2	$8,780	0.81162	$7,126.02
Year 3	$9,120	0.73119	$6,668.45
Year 4	$9,550	0.65873	$6,290.87
			$27,824.07

NPV = $27,824.07 - $26,320 = $1,504.07