Question

Hi, I am not able to find a correct complete answer to this problem ..can you help with the answer, please? I cannot figure out year 3 and the NPV.

H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,280,000. The fixed asset falls into the three-year MACRS class (MACRS Table). The project is estimated to generate $2,210,000 in annual sales, with costs of $1,200,000. The project requires an initial investment in net working capital of $156,000, and the fixed asset will have a market value of $181,000 at the end of the project. Assume that the tax rate is 35 percent and the required return on the project is 11 percent. What is the net cash flow of the project each year? What is the NPV of the project?

Answer 1

,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,First, we will calculate the annual depreciation for the equipment necessary for the project. The depreciation amount each year will be:

Year 1 depreciation = $2,280,000(0.3333) = $759,924

Year 2 depreciation = $2,280,000(0.4445) = $1,013,460

Year 3 depreciation = $2,280,000(0.1481) = $337,668

So, the book value of the equipment at the end of three years, which will be the initial investment minus the accumulated depreciation, is:

Book value in 3 years = $2,280,000 - ($759,924 + $1,013,460 + $337,668) = $168,948

The asset is sold at a gain to book value, so this gain is taxable.

Aftertax salvage value = $181,000 + ($168,948 - $181,000)(0.35)

= $181,000 - $4,218.20 = $176,781.80

To calculate the OCF, we will use the tax shield approach, so the cash flow each year is:

OCF = (Sales - Costs)(1 - T) + Depreciation(T)

Year 0 = -$2,280,000 - $156,000 = -$2,436,000

Year 1 = ($2,210,000 - $1,200,000)(1 - 0.35) + ($759,924 x 0.35)

= $656,500 + $265,973.40 = $922,473.40

Year 2 = ($2,210,000 - $1,200,000)(1 - 0.35) + ($1,013,460 x 0.35)

= $656,500 + $354,711 = $1,011,211

Year 3 = ($2,210,000 - $1,200,000)(1 - 0.35) + ($337,668 x 0.35) + $156,000 + $176,781.80

= $656,500 + $118,183.80 + $156,000 + $176,781.80 = $1,107,465.60

NPV = PV of Cash Inflows - PV of Cash Outflows

= [$922,473.40/1.11] + [$1,011,211/1.11²] + [$1,107,465.60/1.11³] - $2,436,000

= $831,057.12 + $820,721.53 + $809,769.30 - $2,436,000 = $25,547.95