Question

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.34 million. The fixed asset qualifies for 100 percent bonus depreciation in the first year. The project is estimated to generate $1,740,000 in annual sales, with costs of $644,000. The project requires an initial investment in net working capital of $310,000, and the fixed asset will have a market value of $270,000 at the end of the project. a. If the tax rate is 21 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567.) b. If the required return is 10 percent, what is the project's NPV? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to two decimal places, e.g., 1,234,567.89.)

Answer 1

Initial Fixed Asset Investment = $2.34 million = 2.34 x 1000000 =2340000

Since the asset qualifies for 100% bonus depreciation in year 1

Depreciation for year 1 = 100% of initial fixed asset investment = 100% x 2340000 = 2340000

Since 100% bonus depreciation has been claimed therefore depreciation for each of other years i.e year 1 to 3 will 0

Initial Cash flow = Cash flow in year 0 = - Initial fixed asset investment - investment in net working capital = -2340000 - 310000 = -2650000

Calculation of after tax operating cash flows

After tax operating cash flow =EBIT (1-tax rate) + Depreciation = (Sales - Costs - Depreciation)(1-tax rate) + Depreciation

Calculating after tax operating cash flow
Year	1	2	3
Sales	1740000	1740000	1740000
Cost	644000	644000	644000
Depreciation	2340000	0	0
EBIT	-1244000	1096000	1096000
EBIT(1-tax rate)	-982760	865840	865840
Plus: Depreciation	2340000	0	0
After tax operating cash flow	1357240	865840	865840

Calculating Terminal Cash flow

Book value of fixed asset at the end of 3 years = Initial investment in fixed asset - (Sum of depreciation for year 1 to 3)

= 2340000 - (2340000 + 0 + 0) = 2340000 - 2340000 = 0

Terminal Cash flow = Salvage value of fixed Asset at end of 3 years + Recovery of investment in working capital + tax on gain of sale of fixed assets

= Salvage value of fixed Asset at end of 3 years + Recovery of investment in working capital + tax rate ( Salvage value of fixed asset at the end of 3 years - Book value of fixed asset at the end of 3 years)

= 270000 + 310000 - 21% (270000 - 0) = 270000 + 310000 - 56700

= 523300

Calculating cash flow for year 1 to 3

Cash Flow for year 1 to 3
Year	1	2	3
After tax operating cash flow (a)	1357240	865840	865840
Termnal Cash flow (b)			523300
Cash Flow = (a) + (b)	1357240	865840	1389140

NPV of the project = initial cash flow in year 0 + Sum present values of cash flow of year 1 to 3 discounted at 10%

= -2650000 + 1357240/(1+10%) + 865840/(1+10%)² + 1389140/(1+10%)³

= -2650000 + 1233854.55 + 715570.25 + 1043681.44 = 343106.24

Therefore NPV of project = 343106.24