Question

Outdoor Sports is considering adding a putt putt golf course to its facility. The course would cost $171,000, would be depreciated on a straight-line basis over its 4-year life, and would have a zero salvage value. The sales would be $97,400 a year, with variable costs of $27,600 and fixed costs of $12,200. In addition, the firm anticipates an additional $16,900 in revenue from its existing facilities if the putt putt course is added. The project will require $2,800 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 14 percent and a tax rate of 34 percent?

Multiple Choice

• $19,024

• $13,476

• $16,276

• $14,618

• $53,335

Answer 1

Tax rate		34%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4		Total
Cost		$       171,000	$      171,000	$       171,000	$       171,000
Dep Rate		25.00%	25.00%	25.00%	25.00%
Depreciation	Cost * Dep rate	$         42,750	$        42,750	$         42,750	$         42,750		$       171,000
Calculation of after-tax salvage value
Cost of machine			$      171,000
Depreciation			$      171,000
WDV	Cost less accumulated depreciation	$                -
Sale price			$                -
Profit/(Loss)	Sale price less WDV	$                -
Tax	Profit/(Loss)*tax rate	$                -
Sale price after-tax	Sale price less tax		$                -
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4
Sale		$         97,400	$        97,400	$         97,400	$         97,400
Additional revenue from existing unit		$         16,900	$        16,900	$         16,900	$         16,900
Less: Operating Cost		$         27,600	$        27,600	$         27,600	$         27,600
Contribution		$         86,700	$        86,700	$         86,700	$         86,700
Less: Fixed cost		$         12,200	$        12,200	$         12,200	$         12,200
Less: Depreciation		$         42,750	$        42,750	$         42,750	$         42,750
Profit before tax (PBT)		$         31,750	$        31,750	$         31,750	$         31,750
Tax@34%	PBT*Tax rate	$         10,795	$        10,795	$         10,795	$         10,795
Profit After Tax (PAT)	PBT - Tax	$         20,955	$        20,955	$         20,955	$         20,955
Add Depreciation	PAT + Dep	$         42,750	$        42,750	$         42,750	$         42,750
Cash Profit after-tax		$         63,705	$        63,705	$         63,705	$         63,705
Calculation of NPV
						14.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$     (171,000)	$         (2,800)		$     (173,800)	1.0000	$     (173,800)
1				$         63,705	$         63,705	0.8772	$         55,882
2				$         63,705	$         63,705	0.7695	$         49,019
3				$         63,705	$         63,705	0.6750	$         42,999
4		$                 -	$          2,800	$         63,705	$         66,505	0.5921	$         39,376
					Net Present Value	$         13,476
Hence option B is the correct solution.