Question

Yellow Sand Consulting is considering a project that would last for 2 years. The project would involve an initial investment of 93,000 dollars for new equipment that would be sold for an expected price of 78,000 dollars at the end of the project in 2 years. The equipment would be depreciated to 23,000 dollars over 7 years using straight-line depreciation. In years 1 and 2, relevant annual revenue for the project is expected to be 90,000 dollars per year and relevant annual costs for the project are expected to be 24,000 dollars per year. The tax rate is 50 percent and the cost of capital for the project is 5.37 percent. What is the net present value of the project?

Answer 1

Calculation of Net Present Value of Project :

Below is the table showing Calculation of Net Present Value :

	Year 0	Year 1	Year 2
Initial Investment	93000
Annual Sales		90000	90000
Less :Annual Cost		24000	24000
Less : Depreciation (Working Note )		10000	10000
Earning before taxes		56000	56000
Taxes @ 50%		-28000	-28000
Earnings After Taxes		28000	28000
Add : Depreciation		10000	10000
Plus : Salvage Value			78000
Less : tax on salvage @ 50%			2500
Operating Cash Flows	93000	38000	113500
PV Factor @ 5.37%	1	0.949037	0.900671
PV of Net Cash flows (Inflow)		36063.4	102226.1
PV of Net Cash flows (Outflow)	93000
The net present value (NPV) of this project is	= $ 45289.5213 or $ 45,289.52
NPV = PV of cash inflow - PV of cash outflow
= 138289.5213 - 93000
= $ 45289.5213 or $ 45,289.52
Working Note :
Depreciation each Year = (Initial Equipment - Salvage Value ) / Number of year of Useful Life
= (93000 - 23000) / 7
= 10000
Book Value = (93000-10000-10000) = 73000
Gain on Sale = Salvage Value - Book Value
= 78000 - 73000
= 5000
Tax on Gain on Sale = 5000 * 50% = 2500