Question

Milton Industries wants to purchase new equipment that has a quoted price of $1,000,000. Milton estimates an additional cost of $85,000 will be needed today to have the equipment modified, shipped, and installed. The purchase of this additional equipment will require Milton to invest an estimated $55,000 in net working capital upfront, and this investment should be recovered when Milton sells the equipment. If purchased, the equipment will be employed for a total of five years, and then sold for an estimated $640,000. The equipment will be depreciated straight-line on a five-year schedule. During each of the years that the equipment is in service, it is expected to boost Milton’s sales revenue by $298,000 though annual operating costs (other than depreciation) are also expected to be higher, to the extent of $74,000. Milton faces a marginal tax rate of 25%, and its cost of capital is 7.25%.  The NPV of this project is:

		$142,224
		$101,783
		$95,228
		$118,970
		$80,258

Answer 1

Annual depreciation = (1,000,000 + 85,000) / 5

Annual depreciation = 217,000

Initial investment = 1,000,000 + 85,000 + 55,000 = 1,140,000

Operating cash flow from year 1 to year 5 =(Revenue - costs - depreciation)(1 - tax) + depreciation

Operating cash flow from year 1 to year 5 = (298,000 - 74,000 - 217,000)(1 - 0.25) + 217,000

Operating cash flow from year 1 to year 5 = 5,250 + 217,000

Operating cash flow from year 1 to year 5 = 222,250

Year 5 non operating cash flow = Market value + recovery of NWC - tax(market value - book value)

Year 5 non operating cash flow = 640,000 + 55,000 - (0.25(640,000 - 0)

Year 5 non operating cash flow = 640,000 + 55,000 - 160,000

Year 5 non operating cash flow = 535,000

NPV = Present value of cash inflows present value of cash outflows

NPV = -1,140,000 + 222,250 / (1 + 0.0725)^1 + 222,250 / (1 + 0.0725)^2 + 222,250 / (1 + 0.0725)^3 + 222,250 / (1 + 0.0725)^4 + 222,250 / (1 + 0.0725)^5 + 535,000 / (1 + 0.0725)^5

NPV = $142,224