Question

Antonio Melton, the chief executive officer of Munoz Corporation, has assembled his top advisers to evaluate an investment opportunity. The advisers expect the company to pay $405,000 cash at the beginning of the investment and the cash inflow for each of the following four years to be the following:

  

Year 1			Year 2			Year 3			Year 4
$	91,000		$	101,000		$	126,000		$	191,000

  

Mr. Melton agrees with his advisers that the company should use the discount rate (required rate of return) of 12 percent to compute net present value to evaluate the viability of the proposed project. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

   

Required

a. Compute the net present value of the proposed project. Should Mr. Melton approve the project? (Negative amounts should be indicated by a minus sign. Round your intermediate calculations and final answer to the nearest whole dollar.)

b.&c. Shawn Love, one of the advisers, is wary of the cash flow forecast and she points out that the advisers failed to consider that the depreciation on equipment used in this project will be tax deductible. The depreciation is expected to be $81,000 per year for the four-year period. The company’s income tax rate is 40 percent per year. Use this information to revise the company’s expected cash flow from this project. Compute the net present value of the project based on the revised cash flow forecast. Should Mr. Melton approve the project? (Negative amount should be indicated by a minus sign. Round your intermediate calculations and final answer to the nearest whole dollar.)

	a. Net present value Should Mr. Melton approve the project? b.&c. Net present value Should Mr. Melton approve the project?

Answer 1

a) Net present value

Year	Cash Flow	present Value Factor @12%	Discounted Cash Flow
0	405000	1	-405000
1	91000	0.8928	81245
2	101000	0.7972	81517
3	126000	0.7117	89674
4	191000	0.6355	121381
TOTAL INFLOW			373817

Net Present Value = Discounted Cash Inflow - Discounted Cash Outflow

= 373817 - 405000

= - $31,183

Since the net present value is negative Mr.Melton should not approve the Project.

b) Revised Cash Flows

Year	1	2	3	4
Before Tax Inflow	91000	101000	126000	191000
Less:Depreciation	-81000	-81000	-81000	-81000
Income before taxes	10000	20000	45000	110000
Tax @40%	-4000	-8000	-18000	-44000
After Tax Income	6000	12000	27000	70000
Add; Depreciation	81000	81000	81000	81000
After Tax Cash Outflows	87000	93000	108000	151000

Net present value based on Revised cash flows:

Year	Cash Flow	present Value Factor @12%	Discounted Cash Flow
0	405000	1	-405000
1	87000	0.8928	77674
2	93000	0.7972	74140
3	108000	0.7117	76864
4	151000	0.6355	95961
TOTAL INFLOW			324612

Net Present Value = Discounted Cash Inflow - Discounted Cash Outflow

= 324612 - 405000

= - $80,388

Since the net present value is negative Mr.Melton should not approve the Project.