Question

BITFIT is considering the purchase of new equipment. The equipment costs $360,000, and an additional $120,000 is needed to install it. The equipment will be depreciated straight-line to zero over a 6-year life. The equipment will generate additional annual revenues of $265,000, and it will have annual cash operating expenses of $80,000. The equipment will be sold for $75,000 after 6 years. An inventory investment of $73,000 is required during the life of the investment and will be recovered by the end of the project. The company tax rate is 30 percent, and its cost of capital is 10 percent. What is the project NPV?

Part b. Explain how each of the following inputs is used to calculate initial investment:

1. Cost of new asset

2. Installation costs

3. Proceeds from sale of old asset

4. Taxes on sale of old asset

5. Change in net working capita

Answer 1

Year	0	1	2	3	4	5	6
1.Cost of equipment	-360000
2.Installation cost	-120000
3.Total cost of equipment(1+2)	-480000
4.NWC reqd. & recovered	-73000						73000
5. After-tax salvage(BV=0) so,(75000*(1-30%))							52500
Operating Cash flows
6.Incremental revenues		265000	265000	265000	265000	265000	265000
7. Incl. cash opg. Exp.		-80000	-80000	-80000	-80000	-80000	-80000
8. Incl.depn.(480000/6)		-80000	-80000	-80000	-80000	-80000	-80000
9. Incl.EBIT(sum 6 to 8)		105000	105000	105000	105000	105000	105000
10. Tax at 30%(9*30%)		-31500	-31500	-31500	-31500	-31500	-31500
11. NOPAT(9+10)		73500	73500	73500	73500	73500	73500
12.Add back: depn.(row 8)		80000	80000	80000	80000	80000	80000
13. Opg. Cash flow(11+12)		153500	153500	153500	153500	153500	153500
14. Annual FCFs(3+4+5+13)	-553000	153500	153500	153500	153500	153500	279000
15. PV F at 10%(1/1.1^ yr.n)	1	0.90909	0.82645	0.75131	0.68301	0.62092	0.56447
16. PV at 10%(13*14)	-553000	139545.45	126859.50	115326.82	104842.57	95311.42	157488.23
16. NPV at 10%(sum of row 16)	186374
	(ANSWER)

Part b.How each of the following inputs is used to calculate initial investment

i. Cost of new asset -- is the cash outflow spent on purchasing the asset---increases the initial invetsment

ii. Installation costs---adds to the utility value of the asset, the purpose for which the asset was bought-- hence capitalised along with the cost of the asset & depreciated ----- increases the initial invetsment.

iii.Proceeds from sale of old asset--- cash inflow that reduces the amount spent on the new asset---so decreases the initial investment

iv. Taxes on sale of old asset--- it goes to reduce the net proceeds from sale of the old asset--- cash outflow--increases the impact of initial investment

v. Change in net working capital--- cash outflow --incurred to procure working capital for the project--- increases the intial investment.