Question

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.29 million. The fixed asset falls into the three-year MACRS class (MACRS schedule). The project is estimated to generate $1,715,000 in annual sales, with costs of $624,000. The project requires an initial investment in net working capital of $260,000, and the fixed asset will have a market value of $195,000 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, rounded to two decimal places, e.g., 1,234,567.89.) b. If the required return is 9 percent, what is the project's NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to two decimal places, e.g., 1,234,567.89.)

Answer 1

Initial Investment = $2,290,000
Useful Life = 3 years

Depreciation Year 1 = 33.33% * $2,290,000
Depreciation Year 1 = $763,257

Depreciation Year 2 = 44.45% * $2,290,000
Depreciation Year 2 = $1,017,905

Depreciation Year 3 = 14.81% * $2,290,000
Depreciation Year 3 = $339,149

Book Value at the end of Year 3 = $2,290,000 - $763,257 - $1,017,905 - $339,149
Book Value at the end of Year 3 = $169,689

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $195,000 - ($195,000 - $169,689) * 0.21
After-tax Salvage Value = $189,684.69

Initial Investment in NWC = $260,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$2,290,000 - $260,000
Net Cash Flows = -$2,550,000

Year 1:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($1,715,000 - $624,000) * (1 - 0.21) + 0.21 * $763,257
Operating Cash Flow = $1,022,173.97

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,022,173.97

Year 2:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($1,715,000 - $624,000) * (1 - 0.21) + 0.21 * $1,017,905
Operating Cash Flow = $1,075,650.05

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,075,650.05

Year 3:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($1,715,000 - $624,000) * (1 - 0.21) + 0.21 * $339,149
Operating Cash Flow = $933,111.29

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $933,111.29 + $260,000 + $189,684.69
Net Cash Flows = $1,382,795.98

Answer b.

Required Return = 9%

NPV = -$2,550,000 + $1,022,173.97/1.09 + $1,075,650.05/1.09^2 + $1,382,795.98/1.09^3
NPV = $360,899.62