Question

Marge's Campground is considering adding a miniature golf course to its facility. The course equipment she wants would cost $400,000, and would be depreciated on a straight-line basis over 8 years with zero salvage value. However, Marge estimates that the project will be run for 4 years only, and a 4-year time horizon will be used. Further, assume that the company can sell the equipment for $220,000 at the end of year 4. Marge estimates the income from the golf fees would be $280,000 a year with $100,000 variable cost. The fixed cost would be $50,000. The project will require $10,000 of net working capital which is recoverable at the end of the project. Assume a 20% marginal tax rate for the company and the project’s required rate of return of 16 percent.

1. Calculate annual operating CFs for the miniature golf facility for years 1-4. Show your work.

b. What is the BV of the equipment at the end of year 4? Is there a tax liability or tax credit on the sale of the equipment? Calculate total CF for year 4 including the Terminal value.

c. What is the NPV of this project? Would you accept this project?

Answer 1

Question a:

Operating Cash Flows for Year 1-4 is $114,000

Question b:

Book value of equipment at the end of year 4 is $200,000

Tax liability of the equipment is $4,000

Terminal value in year 4 is $226,000

Question c:

NPV of the project is $33,810.38

Project should be accepted since NPV of the project is positive

Calculation of NPV of the project
Particulars	Year 0	Year 1	Year 2	Year 3	Year 4
Initial Investment
Cost of Machine (A)	-400000
Net working capital investment (B)	-10000
Net Investment (C = A+B)	-410000
Operating Cash Flows
Incremental Revenue (D)		280000	280000	280000	280000
Variable Costs (E )		100000	100000	100000	100000
Fixed Costs (F)		50000	50000	50000	50000
Depreciation (G) $400,000 / 8 years		50000	50000	50000	50000
Profit Before Tax (H = D-E-D-G)		80000	80000	80000	80000
Tax @20% (I = H*20%)		16000	16000	16000	16000
Profit After Tax (J = H-I)		64000	64000	64000	64000
Add back Depreciation (K = G)		50000	50000	50000	50000
Net Operating Cash Flows (L = J+K)		114000	114000	114000	114000
Terminal Value
Sale Value (M)					220000
Book Value (N) $400,000 * 4 / 8					200000
Profit on sale (O = M-N)					20000
Tax on sale (P = O*20%)					4000
After tax sale value (Q = M-P)					216000
Recovery of net working capital (R )					10000
Net terminal value (S = Q+R)					226000
Total Cash Flows (T = C+L+S)	-410000	114000	114000	114000	340000
Discount Factor @16% (U) 1/(1+16%)^n n=0,1,2,3,4	1	0.862068966	0.743162901	0.640657674	0.552291098
Discounted Cash Flows (V = T*U)	-410000	98275.86207	84720.57075	73034.97478	187778.9733
NPV of the Project	33810.38088