Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.29 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life. The project is estimated to generate $1,810,000 in annual sales, with costs of $720,000. The project requires an initial investment in net working capital of $450,000, and the fixed asset will have a market value of $480,000 at the end of the project.

a.	If the tax rate is 25 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3?
b.	If the required return is 12 percent, what is the project's NPV?

Answer 1

Net cashh flows in Year-0
Initial investment in fixed assets					-2290000
Add: Investmennt in Working capital					-450000
Net cash outflows					-2740000
Net cashflows in Year1 and 2 each:
Annual sales			1810000
Less: Annual cost			720000
Less: Depreciation (2290000/3)			763333
Net income before tax			326667
Less: Tax @ 25%			81667
After tax income			245000
Add: Depreciation			763333
Cash inflows in Year1 and 2			1008333
Net cashflows in Year-3
Annual sales			1810000
Less: Annual cost			720000
Less: Depreciation (2290000/3)			763333
Net income before tax			326667
Less: Tax @ 25%			81667
After tax income			245000
Add: Depreciation			763333
Cash inflows				1008333
After tax Salvage value (480000-25%)				360000
Working capital released				450000
Net cash inflows in Year-3				1818333
Net present value
Year	Cashflows	PVF at 12%		Present value
0	-2740000	1		-2740000
1	1008333	0.892857		900297.3
2	1008333	0.797194		803836.9
3	1818333	0.71178		1294254
NPV				258388