Question

Blue Eagle Technology is considering a project that would last for 2 years. The project would involve an initial investment of 149,000 dollars for new equipment that would be sold for an expected price of 134,000 dollars at the end of the project in 2 years. The equipment would be depreciated to 21,000 dollars over 8 years using straight-line depreciation. In years 1 and 2, relevant annual revenue for the project is expected to be 136,000 dollars per year and relevant annual costs for the project are expected to be 48,000 dollars per year. The tax rate is 50 percent and the cost of capital for the project is 7.03 percent. What is the net present value of the project?

Answer 1

Sl.No	Year	0	1	2	Net PV of the project
i	Annual revenue (given)		$136,000	$136,000
ii	Capital gain (Wno:1)		$0	$1,000
iii	Annual costs (given)		$48,000	$48,000
iv	EBITDA (i-ii-iii)		$88,000	$89,000
v	Depreciation (Wno:2)		$16,000	$0
vi	EBIT (iv-v)		$72,000	$89,000
vii	Tax @ 50% (vi*0.5)		$36,000	$44,500
viii	PAT (vi-vii)		$36,000	$44,500
ix	Depreciation (v)		$16,000	$0
x	Capital gain (ii)		$0	-$1,000
xi	Operating cashflow (viii+ix+x)		$52,000	$43,500
xii	Initial investment (given)	-$149,000		$134,000
xiii	Net cashflow (xi+xii)	-$149,000	$52,000	$177,500
xiv	PVF @7.03%	1.0000	1/1.0703 = 0.9343	0.9343/1.0703 = 0.8729
xv	Discounted cashflow (xiii*xiv)	-$149,000	$48,584	$154,940	$54,523

Wno:1

Capital gain = Sale value of equipment - Initial investment - depreciation for year 1 = $134,000-$149,000-$16,000 = $1,000. Assumed it will be taxed @ 50%. As the asset sold in year 2, depreciation will not be allowed as deduction.

Wno:2

Depreciation per annum = (Initial investment - 21,000)/8 = (149,000-21,000)/8 = 128,000/8 = $16,000