Question

Manigault Industries is considering an expansion project. The proposed project would have a 4-year life along with the following features:

• The necessary equipment is priced at $90,000.
• The engineers require a cost of $3,000 to install the equipment and $5,000 to train employees to use the equipment
• The equipment will be depreciated using MACRS 3 year class over 4 years using the following depreciation rates: 33% (year 1), 45% (year 2), 15% (year 3) and 7% (year 4).
• If the project is undertaken, at t = 0 the company will need to increase its inventories by $50,000 and its accounts payable by $30,000.
• The company will realize an additional $500,000 in sales over each of the next four years.
• The company’s operating costs (excluding depreciation) will equal $200,000 a year.
• The company’s tax rate is 40%.
• At t = 4, the equipment will be sold for $30,000.
• The weighted average cost of capital “WACC” is 10%.

1- The after-tax Cash Flow for the 2nd year is: *

A. $196,740

B. $153,540

C. $200,000

D. $30,000

E. None of the above

2- The after-tax Cash Flow for the 3rd year is: *

A. $286,000

B. $20,000

C. $185,580

D. $185,880

E. None of the above

3- The after-tax Cash Flow for the 4th year is: *

A. $182,604

B. $182,744

C. $176,094

D. $117,396

E. None of the above

4- The Book Value of the equipment at termination is: *

A. $30,050

B. $10,500

C. $6,510

D. $0

E. None of the above

5- The Terminal Value (TV) is: *

A. $38,000

B. $61,050

C. $45,485

D. $35,636

E. None of the above

6- The NPV value of the project is: *

A. $514,496

B. $272,500

C. - $296,235

D. -$300,250

E. None of the above

Answer 1

The Free Cashflow calculation is as shown below

	Year
	0	1	2	3	4
Incremental Sales ($)		500000	500000	500000	500000
Incremental operating cost ($)		200000	200000	200000	200000
Depreciation ($)		30690	41850	13950	6510
Earnings before Tax ($)		269310	258150	286050	293490
Tax @40%		107724	103260	114420	117396
Profit After Tax		161586	154890	171630	176094
Add: Depreciation		30690	41850	13950	6510
Capital Cost including Installation	93000
Training	5000
NWC	20000				20000
After tax Salvage value					18000
Free Cashflows	-118000	192276	196740	185580	220604

1. The Free Cashflow in 2nd year is $196740 (option A)

2.  The after-tax Cash Flow for the 3rd year is $185580 (Option C)

3. The after-tax Cash Flow for the 4th year is:$176094+$6510 = $182604 (excluding NWC recovery and Salvage value) (option A)

4. Book value of Equipment at termination is 0 (33%+45%+15%+7% =100% depreciation) OPTION D

5. Terminal Value = After tax salvage value+ NWC recovery

=$18000 + $20000 = $38000 (Option A)

6. NPV = -118000 + 192276/1.1 +196740/1.1^2+185580/1.1^3+220604/1.1^4

=$509496 apx (OPTION E)

Please note that If training cost is not included , the correct answer will be A