Question

Shanks Corporation is considering a capital budgeting project that involves investing $600,000 in equipment that would have a useful life of 3 years and zero salvage value. The company would also need to invest $20,000 immediately in working capital which would be released for use elsewhere at the end of the project in 3 years. The net annual operating cash inflow, which is the difference between the incremental sales revenue and incremental cash operating expenses, would be $300,000 per year. The project would require a one-time renovation expense of $60,000 at the end of year 2. The company uses straight-line depreciation and the depreciation expense on the equipment would be $200,000 per year. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting. The income tax rate is 35%. The after-tax discount rate is 15%.

Required:

Determine the net present value of the project. Show your work!

Answer 1

Year			0	1	2	3		Total
Investment in equipemnt			$       -6,00,000
Investment in working capital			$           -20,000
Sales less Cash operating expense				$   3,00,000	$   3,00,000	$   3,00,000
Depreciation expense				$ -2,00,000	$ -2,00,000	$ -2,00,000
Renovation expense					$     -60,000
Profit before tax				$   1,00,000	$      40,000	$   1,00,000
Tax expense				$     -35,000	$     -14,000	$     -35,000
Net profit				$      65,000	$      26,000	$      65,000
Depreciation expense				$   2,00,000	$   2,00,000	$   2,00,000
Annual Cash inflows				$   2,65,000	$   2,26,000	$   2,65,000
Release of working capital						$      20,000
Total Cash flows			$       -6,20,000	$   2,65,000	$   2,26,000	$   2,85,000
Discount factor @ 15%			1.000	0.870	0.756	0.658
Present Value			$       -6,20,000	$   2,30,435	$   1,70,888	$   1,87,392		$ -31,285
Thus,
Net Present Value of project is			$           -31,285