Question

Fun With Finance is considering a new 3-year expansion project that requires an initial fixed asset investment of $1.458 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $113,400. The project requires an initial investment in net working capital of $162,000. The project is estimated to generate $1,296,000 in annual sales, with costs of $518,400. The tax rate is 34 percent and the required return on the project is 10 percent. Required: (a) What is the project's year 0 net cash flow? (b) What is the project's year 1 net cash flow? (c) What is the project's year 2 net cash flow? (d) What is the project's year 3 net cash flow? (e) What is the NPV?

Answer 1

Time line		0	1	2	3
Cost of new machine		-1458000
Initial working capital		-162000
=Initial Investment outlay		-1620000
Sales			1296000	1296000	1296000
Profits	Sales-variable cost		777600	777600	777600
-Depreciation	Cost of equipment/no. of years		-486000	-486000	-486000
=Pretax cash flows			291600	291600	291600
-taxes	=(Pretax cash flows)*(1-tax)		192456	192456	192456
+Depreciation			486000	486000	486000
=after tax operating cash flow			678456	678456	678456
reversal of working capital					162000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				74844
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					236844
Total Cash flow for the period		-1620000	678456	678456	915300
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-1620000	616778.18	560707.438	687678.44
NPV=	Sum of discounted CF=	245164.057