Question

VNM is considering a new project that complements its existing business. The machine required for the project costs $3.6 million. The marketing department predicts that sales related to the project will be $2.5 million per year for the next four year, after which the market will cease to exist.

The machine will be depreciated down to zero over its four-year economic life using the straight line method. Cost of goods sold and operating expenses related to the project are predicted to be 25 percent of sales.

VNM also needs to add net working capital of $150,000 immediately. The additional net working capital will be recovered in full at the end of the project's life. The corporate tax rate is 35%. The required rate of return for VNM is 16%

a/ What is the project's cash flow at year 0 and at the end of year 4?

b/ what is the project's cash flow at the end of year 1,2,3?

c/ shoud VNM proceed with the project

Answer 1

Project cash outflow in year = cost of machine + investment in net working capital

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

Project cash flow in years 1 to 3 = OCF

Project cash flow in year 4 = OCF + recovery of NWC investment

NPV is calculated using NPV function in Excel

NPV is $624,553

Yes, VNM should proceed with the project as the NPV is positive