Question

option shows the estimated increase in gross profit from the improved facility and/or automation at current forecast production levels.  All information is Pre-Tax.  Tax rate = 40%

Option A:

• Cost (time = 0) = $10.0 million, and takes one year to complete and bring online.
• Yr. 1 cash flow = 0.
• Depreciate the project cost over the 5yr allowable write-down of the facility after completion (Yr. 2-6).
• The production line will increase pre-tax revenue by $5.0 million per year starting in yr. 2 and going for five years (Yr. 2-6).  
• The WACC for the firm is 10% and the project risk premium is 4.0%

Termination Value: Six years from today the project is salvaged for $2.0 Million of before tax dollars.

What is the NPV of Option A, answer in dollars?

Answer 1

							IN $ MILLION
Year	0	1	2	3	4	5	6
Increase in pre tax revenue			5	5	5	5	5		WACC	10%
Salvage value							2
Less-Depreciation			2	2	2	2	2		Risk Premium	4%
									Discount rate	14%	WACC+Risk Premium
Increase in Profit before tax			3	3	3	3	5
Less-Tax @40% of Profit before tax			1.2	1.2	1.2	1.2	2		Depreciation per year (in $ million)	2	Cost/5 years
Profit after tax			1.8	1.8	1.8	1.8	3
Add-Depreciation (as non cash expense)			2	2	2	2	2
Cash flow after tax			3.8	3.8	3.8	3.8	5
Present value of Inflow after tax			2.923977	2.564892	2.249905	1.973601	2.277932738
	$ millions
Sum of Present value of Inflows	11.99031
Outflow	10
NPV	1.990307