Question

Howell Petroleum is considering a new project that complements its existing business. The machine required for the project costs $3.95 million. The marketing department predicts that sales related to the project will be $2.65 million per year for the next four years, after which the market will cease to exist. The machine will be depreciated down to zero over its four-year economic life using the straight-line method. Cost of goods sold and operating expenses related to the project are predicted to be 20 percent of sales. The company also needs to add net working capital of $300,000 immediately. The additional net working capital will be recovered in full at the end of the project’s life. The corporate tax rate is 35 percent. The required rate of return is 14 percent.
  
What is the NPV for this project?

Should the company proceed with the project?

Answer 1

Ref	Particulars		Year 1	Year 2	Year 3	Year 4
a	Operating cash flow		$    2,120,000.00	$         2,120,000.00	$ 2,120,000.00	$ 2,120,000.00
	Salvage value
b	Depreciation		$      (987,500.00)	$           (987,500.00)	$    (987,500.00)	$    (987,500.00)
c=a-b	Profit before tax		$    1,132,500.00	$         1,132,500.00	$ 1,132,500.00	$ 1,132,500.00
	Profit after tax		$        736,125.00	$            736,125.00	$     736,125.00	$     736,125.00
	Add depreciation		$        987,500.00	$            987,500.00	$     987,500.00	$     987,500.00
	Add: working capital		$                        -	$                             -	$                      -	$     300,000.00
	Free cash flow		$    1,723,625.00	$         1,723,625.00	$ 1,723,625.00	$ 2,023,625.00
d	Present value factor@ 14.0%		0.877192982	0.769467528	0.674971516	0.592080277
e=c*d	Present value of annual cashflows		$    1,511,951.75	$         1,326,273.47	$ 1,163,397.78	$ 1,198,148.45
	Total present value of annual cash inflows		$    5,199,771.45
	Investment:
	Equipment		$   (3,950,000.00)
	Working capital		$      (300,000.00)
	NPV		$        949,771.45

NPV is $949,771.45