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

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

annual depreciation =

-200000

tax on salvage = 700000*0.4 = 280000

OCF

362000

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

jeff jeffy answered 1 year ago

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