Question

Manufacturing is thinking about expanding its facilities and its finance staff has obtained the following information:

• The expansion will require the company to purchase today (t = 0) $5million of equipment.  The equipment will be depreciated over the following four years at the following rates: .33, .45, .15 and .07 in years 1,2,3,4, respectively.
• The expansion will require the company to increase its net operating working capital by $500,000 today (t=0).  This net operating working capital will be recovered at the end of four years (t=4).
• The equipment is not expected to have any salvage value at the end of four years.
• The company’s operating costs, excluding depreciation, are expected to be 60 percent of the company’s annual sales.
• The expansion will increase the company’s dollar sales.  The projected increases, all relative to current sales are: 3, 3.5, 4.5 and 4 in years 1,2,3,4, respectively (in $millions). (For example, in Year 4 sales will be $4 million more than they would have been had the project not been undertaken.)  After the fourth year, the equipment will be obsolete, and will no longer provide any additional incremental sales.
• The company’s tax rate is 40 percent and the company’s other divisions are expected to have positive tax liabilities throughout the project’s life.
• The WACC for the project is 10%.

For the project, what is (a) the initial cash outlay, (b) the operating cash flows over the four years, (c) the terminal cash flow, (d) the project’s NPV?

Answer 1

(a) the initial cash outlay = -$5500000,

(b) the operating cash flows over the four years,

Year 1 = $1380000

Year 2 = $1740000

Year 3 = $1380000

Year 4 = $1100000

(c) the terminal cash flow, = $500000

(d) the project’s NPV? = -$677802.06