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

Calculation of NPV of the Project
Particulars	0	1	2	3
Initial Investment
Cost of Project	-150000
Investment in net working capital	-40000
Net Investment (A)	-190000
Operating Cash Flows
Annual Sales (B)		450000	450000	450000
Variable Costs (C )		200000	200000	200000
Fixed Costs (D)		100000	100000	100000
Depreciation (E ) ($150,000 / 3 years)		50000	50000	50000
Profit Before Tax (F = B-C-D-E)		100000	100000	100000
Tax @ 25% (G = F*25%)		25000	25000	25000
Profit After Tax (H = F-G)		75000	75000	75000
Add back depreciation (I)		50000	50000	50000
Net Operating Cash Flows (J = H+I)		125000	125000	125000
Terminal Value
Salvage Value (K)				60000
Tax @25% (L = K*25%)				15000
After tax Salvage Value (M = K-L)				45000
Recovery of net working capital (N)				40000
Net Terminal Value (O = M+N)				85000
Total Cash Flows (P = A+J+O)	-190000	125000	125000	210000
Discount Factor @16% (Q) 1/(1+16%)^n n=0,1,2,3	1	0.862068966	0.743162901	0.640657674
Discounted Cash Flows (R = P*Q)	-190000	107758.6207	92895.36266	134538.1114
NPV of the Project	145192.0948
Therefore, NPV of the project is $145,192.09