Middlefield Motors is evaluating project Z. The project would require an initial investment of 72,500 dollars...

Middlefield Motors is evaluating project Z. The project would require an initial investment of 72,500 dollars that would be depreciated to 13,000 dollars over 5 years using straight-line depreciation. The first annual operating cash flow of 27,500 dollars is expected in 1 year, and annual operating cash flows of 27,500 dollars are expected each year forever. Middlefield Motors expects the project to have an after-tax terminal value of 353,500 dollars in 5 years. The tax rate is 20 percent. What is (X+Y)/Z if X is the project’s relevant expected cash flow for NPV analysis in year 5, Y is the project’s relevant expected cash flow for NPV analysis in year 6, and Z is the project’s relevant expected cash flow for NPV analysis in year 4?

Expert Solution

Calculation of depreciation of the project = initial investment - salvage value.

here salvage is 13,000. hence 72,500 - 13,000 = 59,500

depreciation each year = 59,500 / 5 (life of the project)

= 11,900

the cash flow for the calculation of NPV must be cash flow before depreciation and after-tax.

hence for calculating that we need to decrease depreciation first deduct tax and add back the depreciation amount to the after-tax cash flows.

In this investment project, we have a cashflow of 27,500 every year. Hence reduce 11900 from 27,500 and then deduct tax of 20%

therefore the cash flow before depreciation after tax would be 24,380. throughout the lifetime of the project.

the project will have a cash flow of 24,380 for NPV analysis from year 1 to 5.

here we have cashflow for npv analysis hence we can give values to X AND Z. It is being said that Y represents the cash flow for year 6. which we can find out. It is clearly mentioned that cash flow will be same forever.

therefore cash flow before depreciation and tax will be 27500. Hence no information is given about depreciation we assume that the depreciation value remains zero and tax rate will remain at 20%

therefore the value for Y will be after and but before depreciation = 22,000

then x + y / z = (24,380 + 22,000) / 24,380

= 1.9024

jeff jeffy answered 1 year ago

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