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 qualifies for 100 percent bonus depreciation in the first year. The project is estimated to generate $1.735 million in annual sales, with costs of $650,000. The project requires an initial investment in net working capital of $250,000, and the fixed asset will have a market value of $180,000 at the end of the project. The tax rate is 21 percent.

a.	What is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)
b.	If the required return 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

a
Cash flow in year 0 = Initial fixed investment + Net working capital
Cash flow in year 0	-2320000-250000
Cash flow in year 0	-2570000
Calculation of net cash flow in year 1, 2 and 3
	Year 1	Year 2	Year 3
Sales	$1,735,000	$1,735,000	$1,735,000
Less: Costs	$650,000	$650,000	$650,000
Depreciation	$2,320,000	$0	$0
Income before tax	-$1,235,000	$1,085,000	$1,085,000
Tax @ 21%	-$259,350	$227,850	$227,850
Net Income	-$975,650	$857,150	$857,150
Add: Depreciation	$2,320,000	$0	$0
Net cash flow	$1,344,350	$857,150	$857,150
Recovery of NWC			$250,000
Aftertax salvage value			$142,200
180000*(1-0.21)
Net cash flow	$1,344,350	$857,150	$1,249,350
The value of fixed assets is 0 and so the entire $180,000 is the profit on sale, on which tax would be applicable
b
Calculation of net present value
	Year 0	Year 1	Year 2	Year 3
Net cash flow	-$2,570,000.00	$1,344,350.00	$857,150.00	$1,249,350.00
Discount rate @ 12%	$1.00000	$0.89286	$0.79719	$0.71178
Present value	-$2,570,000.00	$1,200,312.50	$683,314.73	$889,262.65
Net present value	$202,889.88
The project's NPV is $202,889.88