Question

Your company is considering a project which will require the purchase of $805,000 in new equipment. The company expects to sell the equipment at the end of the project for 25% of its original cost, but some assets will remain in the CCA class. Annual sales from this project are estimated at $292,000. Initial net working capital equal to 36.50% of sales will be required. All of the net working capital will be recovered at the end of the project. The firm requires a 12.25% return on similar investments. The tax rate is 35%, and the project life is 5 years. There are no other operating expenses. Assume the present value of the CCA tax shield is $136,000. What is the project's NPV?

a) 71340

b) 73269

c)75197

d)77125

e)79053

Answer 1

Answer: d)77,125

Computation of present value of operating cashflow:

Sl.No	Year	0	1	2	3	4	5	Total
i	Annual sales (given)		$292,000	$292,000	$292,000	$292,000	$292,000
ii	Tax @ 35% (i*0.35)		$102,200	$102,200	$102,200	$102,200	$102,200
iii	Operating cashflow (i-ii)		$189,800	$189,800	$189,800	$189,800	$189,800
iv	Purchase/sale of equipment (given)	-$805,000					$805,000*0.25 = $201,250
v	Net working capital ($292,000*0.365)	-$106,580					$106,580
vi	Net cashflow (iii+iv+v)	-$911,580	$189,800	$189,800	$189,800	$189,800	$497,630
vii	PVF @ 12.25%	1	1/1.1225 = 0.8909	0.8909/1.1225 = 0.7937	0.7937/1.1225 = 0.7071	0.7071/1.1225 = 0.6299	0.6299/1.1225 = 0.5612
viii	Present value of operating cashflow (vi*vii)	-$911,580	$169,093	$150,644	$134,208	$119,555	$279,270	-$58,810

NPV = PV of operating cashflow+PV of CCA tax shield = -$58,810+$136,000 = $77,190 (Note nearest option is selected)