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Sway's Back Store is considering a project which will require the purchase of $1.5 million in...

  1. Sway's Back Store is considering a project which will require the purchase of $1.5 million in new equipment. The equipment will be depreciated straight-line to a book value of $0.5 million over the 5-year life of the project. Annual sales from this project are estimated at $950,000. The variable cost is 40% of the annual sales and there is an annual fixed cost of $100,000. Sway's Back Store will sell the equipment at the end of the project for a salvage value of $0.7 mil. Additional net working capital equal to $0.4 mil to support the project. All of the new net working capital will be recouped at the end of the project. The firm desires a minimal 10% rate of return on this project. The tax rate is 40%. You can use the following tables to construct the cash flows necessary for the NPV calculation. (10 points)

a. What is the annual depreciation? *** Straight line depreciation expense = (beginning value- ending value) / life expectancy

b. What is the TAX on salvage? *** Taxes on salvage = Tax rate * Capital Gain

C. What is the operating cash flow?

***Operating Cash Flow = (Sales-Costs-Depreciation) – Taxes + Depreciation

          or = Net Income + Depreciation

d. What is the project's NPV?

Solutions

Expert Solution

a.

annual depreciation =

-200000

b.

tax on salvage = 700000*0.4 = 280000

c.

OCF

=

362000

d.

Time line 0 1 2 3 4 5
Cost of new machine -1500000
Initial working capital -400000
=Initial Investment outlay -1900000
Sales 950000 950000 950000 950000 950000
Profits Sales-variable cost 570000 570000 570000 570000 570000
Fixed cost -100000 -100000 -100000 -100000 -100000
-Depreciation (purchase price-last yr book value)/5 -200000 -200000 -200000 -200000 -200000
=Pretax cash flows 270000 270000 270000 270000 270000
-taxes =(Pretax cash flows)*(1-tax) 162000 162000 162000 162000 162000
+Depreciation 200000 200000 200000 200000 200000
=after tax operating cash flow 362000 362000 362000 362000 362000
reversal of working capital 400000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 420000
+Tax shield on salvage book value =Salvage value * tax rate 200000
=Terminal year after tax cash flows 1020000
Total Cash flow for the period -1900000 362000 362000 362000 362000 1382000
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331 1.4641 1.61051
Discounted CF= Cashflow/discount factor -1900000 329090.91 299173.554 271975.96 247250.87 858113.3
NPV= Sum of discounted CF= 105604.56

b

jeff jeffy answered 2 years ago
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