Question

Enlightened Ltd is investigating the introduction of a new advanced solar light. Forecast revenue from the new light is $1,250,000 per year and variable costs $450,000 per year. The revenue and variable costs are expected to stay constant for the four years. The new light will require a new production line that will have an initial cost of $2,000,000. For tax purposes you can depreciate the full cost down to zero over the four year life of the project. At the end of four years you expect to be able to sell the production machinery for $350,000. Selling the new fixtures will require additional working capital of $25,000 starting immediately. You expect to recover the working capital investment at the end of the four year project. You have already spent $50,000 in research and development costs to invent the new light.Assume the tax rate is 30% and the required return is 10% APR (compounded annually).

What are the Project Cash Flows for the project?

DO NOT USE EXCEL FOR CALCULATIONS

Answer 1

Particulars	Year 0	Year 1	Year 2	Year 3	Year 4
Revenues	$0	$1,250,000	$1,250,000	$1,250,000	$1,250,000
Less: Variable costs	$0	($450,000)	($450,000)	($450,000)	($450,000)
Contribution	$0	$800,000	$800,000	$800,000	$800,000
Less: Depreciation	$0	($500,000)	($500,000)	($500,000)	($500,000)
PBT	$0	$300,000	$300,000	$300,000	$300,000
Less: Tax @ 30%	$0	($90,000)	($90,000)	($90,000)	($90,000)
PAT	$0	$210,000	$210,000	$210,000	$210,000
Add: Depreciation	$0	$500,000	$500,000	$500,000	$500,000
Less: Changes in Working capital	$0	($25,000)	($25,000)	($25,000)	($25,000)
Add: Recovery of working capital					$100,000
Add: Sale proceeds of production machinery (Post tax)					$245,000
Less: Investment in new production line	($2,000,000)
Cash flow	($2,000,000)	$685,000	$685,000	$685,000	$1,030,000
Discount factor @10%	1.00	0.91	0.83	0.75	0.68
Discounted cash flows	(2,000,000)	622,727	566,116	514,651	703,504
Present value of project	406,997