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. {“cash flow from assets” is the same as “free cash flow”}

(b) What is the NPV of the project?

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

Answer 1

Solution :- Depreciation per year = $25,000,000 / 5 = $5,000,000

After tax Salvage Value = $5,000,000 * ( 1 - 0.20 ) = $4,000,000

Now (A) Cash flow from Assets Each Year =

Year 0 = - $25,0000,000

Year 1 - 4 = $6,600,000

Year 5 = $10,600,000

(B) NPV of Project = $4,074,219.03

(C) Change in NPV = ( $4,074,219.03 - $3703,848.66 ) = $370,370.37

$370,370.37 / $4,074,219.03 = 0.0909 = 9.09%

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