Question

ABC Corp. is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 21%. 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. Depreciation is calculated using the 5-year MACRS schedule, and the fixed asset will have a salvage value equal to 25% of the original cost at the end of year 4. All net working capital is recovered at the end of the project

	Year 0	Year 1	Year 2	Year 3	Year 4
Investment in fixed asset	$30,000				A
Sales revenue		$14,000	$15,000	$16,000	$13,000
Operating costs		3,000	3,500	4,000	2,800
Depreciation		B	C	D	E
NWC spending	300	200	150	100	F

1. Compute the values of annual depreciation expenses (B, C, D and E), the after-tax salvage cash flow (A) and the Net working Capital recovery value (F)

2. Compute the incremental net income of the investment for each year.

3. Compute the incremental cash flows of the investment for each year

4. Suppose the appropriate discount is 10 percent. What is the NPV of the project? Should the project go ahead?

Answer 1

Solution :-

Book value after Years = $30,000 - ( $6,000 + $9,600 + $5,760 + $2,304 ) = $6,336

Salvage Value = 25% * $30,000 = $7,500

Now Gain on Sale = $7,500 - $6,336 = $1,164

Tax on gain on sale = 21% * $1,164 = $244.44

After tax Salvage Value = $7,500 - $244.44 = $7,255.56

(a)

A = $7,255.56

B = $6,000

C = $9,600

D = $5,760

E = $2,304

F = $450

(b)

Net Income

Yr 1 = $3,950

Yr 2 = $1,501

Yr 3 = $4,930

Yr 4 = $6,238

(c)

Incremental Cash flows =

Yr 1 = $9,750

Yr 2 = $10,951

Yr 3 = $10,589

Yr 4 = $16,247.70

(d)

NPV = $6,967.37

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