Question
In: Finance
Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed...
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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? |
Solutions
Expert Solution
| 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 | |||||
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