Question

6. A firm is deciding on a new project. Use the following information for the project evaluation and analysis: - The initial costs are $450,000 for fixed assets. The fixed assets will be depreciated straight line to a zero book value over the 3-year life of the project. The fixed assets have an estimated salvage value of $30,000 at the end of the project. - The project also requires an additional $100,000 for net working capital to start the project. All of the net working capital will be recouped at the end of the 3 years. - The project is expected to generate annual sales of $1,000,000 (1,000 units at $1,000) and total costs of $550,000 per year - The firm’s marginal tax rate is 40 percent. - The required rate of return for this project is 20% What is the NPV for this project

Answer 1

Annual depreciation = 450,000 / 3

Annual depreciation = 150,000

Initial investment = Cost + net working capital

Initial investment = 450,000 + 100,000

Initial investment = $550,000

Operating cash flow from year 1 to year 3 cash flow = (Sales - total costs - depreciation)(1 - tax) + depreciation

Operating cash flow from year 1 to year 3 cash flow = (1,000,000 - 550,000 - 150,000)(1 - 0.4) + 150,000

Operating cash flow from year 1 to year 3 cash flow = 330,000

Year 3 non operating cash flow = Market value + NWC - Tax(market value - book value)

Year 3 non operating cash flow = 30,000 + 100,000 - 0.4(30,000 - 0)

Year 3 non operating cash flow = 30,000 + 100,000 - 12,000

Year 3 non operating cash flow = $118,000

NPV = Present value of cash inflows - present value of cash outflows

NPV = -550,000 + 330,000 / (1 + 0.2)¹ + 330,000 / (1 + 0.2)² + 330,000 / (1 + 0.2)³ + 118,000 / (1 + 0.2)³

NPV = $213,425.93