Question

A three-year project will cost $150,000 to construct. This will be depreciated straight line to zero over the three-year life. The project is expected to generate sales of $450,000 per year. It has annual variables costs of $200,000 and annual fixed costs of $100,000 per year. The appropriate tax rate is 25 percent and the required rate of return on the project is 16 percent. Assume that a salvage company will pay $60,000 (before taxes) for the assets at the end of year 3. The project also has an initial net working capital requirement of $40,000, which is fully recoverable when the project ends. Note that the project only depreciates the $150,000 initial cost. The salvage value is excluded from depreciation. What is the project’s net present value (NPV)?

     

Answer 1

> Formula

NPV = Present Value of Cash inflow (PVCI) - Present Value of Cash outflow (PVCO)

> Calculation

PVCO = Construction Cost + Working capital requirement

          = 150000 + 40000

          = 190000

PVCI

Particulars	Year 1	Year 2	Year 3
Sales	450000	450000	450000
Less: Variable Cost	( 200000 )	( 200000 )	( 200000 )
Less: Fixed Cost	( 100000 )	( 100000 )	( 100000 )
Less: Depreciation [150000 / 3 years ]	( 50000 )	( 50000 )	( 50000 )
Profit before tax	100000	100000	100000
Less: Tax @ 25%	(25000)	(25000)	(25000)
Profit After Tax	75000	75000	75000
Add: Depreciation	50000	50000	50000
Cashflow after tax	125000	125000	125000
Add: Salvage ( 1 - Tax rate)			60000 * ( 1 - 0.25) = 45000
Add: Working capital			40000
Cash Inflow	125000	125000	210000
PV Factor @ 16%	0.8621	0.7432	0.6407
Present Value of Cash inflow	107762.5	92900	134547

PVCI = Sum of Present Value of Cash inflow

         = 335210

NPV = 335210 - 190000

        = $ 145210 Answer

Hope you understand the solution.