Question

You just finished calculating the NPV of project A and found it to be $49,242. A concurrent project, which will use the same resources as project A is now before you as well. This is project B, which will require a $2M investment in an asset that will have a $1M salvage value at the end of the project. A total of $170,000 was invested in the consulting and research leading to the marketability of the product. Project B will generate annual sales of $1.5M and total costs of $1.1M. The firm’s cost of capital is 7.5%, its tax rate is 30%, and the CCA depreciation for this asset is 20%. Project B will trigger a net change in working capital of $130,000. The project will last 6 years. Calculate the NPV of this project and say clearly whether you would accept it. You must show your work to get full points. 12 points.

Answer 1

Based on the given data, pls find below workings;

Consulting cost is not considered in the working as the same is already expensed out and is a sunk cost.

Book Value (Cost - Accumulated Depreciation) is calculated at end of Year 6, to calculate capital gains/(Loss) as compared to the salvage value and thus tax on the capital gains/ (loss).

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;

Based on these workings, the NPV of the Project B is $ 50617.43; This project is feasible to accept and also having higher NPV than that of Project A.