Question

TechSquare. LLC. is considering a 5-year new project. The project will require $325,000 for fixed assets and $95 of working capital. The fixed assets will be depreciated straight-line to a zero-book value over 5 year. At the end of the project, the fixed assets can be sold for 25% of their original cost. The project is expected to generate annual sales of $554,000 with costs of $430,000. The tax rate is 21% and the required rate of return is 15%. What are the NPV and PI of this project?

Answer 1

Answer:

Initial Investment = $325,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $325,000 / 5
Annual Depreciation = $65,000

Initial Investment in NWC = $95

Salvage Value = 25% * $325,000
Salvage Value = $81,250

After-tax Salvage Value = $81,250 * (1 - 0.21)
After-tax Salvage Value = $64,187.50

Annual Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = ($554,000 - $430,000) * (1 - 0.21) + 0.21 * $65,000
Annual Operating Cash Flow = $111,610

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$325,000 - $95
Net Cash Flows = -$325,095

Year 1 to Year 4:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $111,610

Year 5:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $111,610 + $95 + $64,187.50
Net Cash Flows = $175,892.50

Required return = 15%

Present Value of Cash Inflows = $111,610/1.15 + $111,610/1.15^2 + $111,610/1.15^3 + $111,610/1.15^4 + $175,892.50/1.15^5
Present Value of Cash Inflows = $406,093.79

Net Present Value = Present Value of Cash Inflows - Initial Cash Outflow
Net Present Value = $406,093.79 - $325,095.00
Net Present Value = $80,998.79

Profitability Index = Present Value of Cash Inflows / Initial Cash Outflow
Profitability Index = $406,093.79 / $325,095.00
Profitability Index = 1.25