Question

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.32 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1.735 million in annual sales, with costs of $650,000. The tax rate is 21 percent and the required return on the project is 12 percent. What is the project’s NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

Year 0 Cash flow  
Initial fixed asset inv.   -2320000.00
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Total Cash flow at year 0 .......   -2320000.00
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Cash flow from Year 1 to 3  
annual sales generated.....   1735000.00
less: cost   -650000.00
less: Depreciation    -773333.33
(2320000/3)  
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Operating profit............   311666.67
less tax @ 21%................   -65450.00
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Profit after tax ......................   246216.67
Add: Depreciation..........   773333.33
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Operating cash flow ............   1019550.00
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Note:  
(1) Depreciation is non cash expenses. It is only deducted for tax calculation. Again it will be added as it is not in cash.  
  
Calculation of NPV  
Discount rate (r)=    12%
Number of years (n)=    3
  
Year 0 cash flows present value is same as   -2320000.00
Year 1 to 3 have uniform cash inflows. So Present Value of Annuity formula will be used.  

Present value of Cash inflows = Annual amount * (1-(1/(1+r)^n) / r  
1019550*(1-(1/(1+12%)^3))/12%  
2448787.07  

NPV is Sum of present value of all cash flows  
-2320000+   2448787.07
128787.07  

NPV is Positive   128787.07
So project should be accepted