Question

Bayside Industries Inc. is evaluating an expansion project to establish its presence in a key market for its products. You have collected the following data on the proposed project:

• The project requires $25 million in initial capital investment, and will have an economic life of 5 years. The investment will be straight-line depreciated down to a book value of zero at the end of 5 years. The investment is expected to be salvaged for $5 million at the end of 5 years.
• The projected sales are $20 million per year from year 1 through year 5, variable costs are 50% of annual sales, and fixed costs are $3 million per year.
• The corporate tax rate is 20 percent.
• The weighted average cost of capital applicable to the proposed project is 8%
• Ignore investment in net working capital.

(a) Please compute the cash flow from assets for each year. [12 points] {“cash flow from assets” is the same as “free cash flow”}

(b) What is the NPV of the project? [5 points]

(c) If the projected annual sales decrease by 5% to $19 million per year, how much would the project’s NPV change? (8 points)

Answer 1

a] and b]

Operating cash flow (OCF) each year = income after tax + depreciation

profit on sale of investment at end of year 5 = sale price - book value

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value - tax on profit on sale of investment   

NPV is calculated using NPV function in Excel

NPV is $4,074,219

c]

NPV is $2,477,135

% change = ($2,477,135 - $4,074,219) / $4,074,219

% change = -39%