Question

Silver Sun Aviation is considering a project that would last for 2 years and have a cost of capital of 17.06 percent. The relevant level of net working capital for the project is expected to be 16,000 dollars immediately (at year 0); 12,000 dollars in 1 year; and 0 dollars in 2 years. Relevant expected revenue, costs, depreciation, and cash flows from capital spending in years 0, 1, and 2 are presented in the following table (in dollars). The tax rate is 50 percent. What is the net present value of this project?

	Year 0	Year 1	Year 2
Revenue	$0	186,000	186,000
Costs	$0	62,000	62,000
Depreciation	$0	49,000	49,000
Cash flows from capital spending	-100,000	0	16,000

there's a table with all the values above

Answer 1

first, we will find the initial investment outlay.

outlay = FCInv + NWCinv = 100000 + 16000. = 116000

where,

FCInv = fixed capital investment = 100000

NWCinv = net working capital investment at 0 = 16000

After tax operating cashflow = ( S - C - D ) (1-T) + D  

After tax operating cashflow in year 1 = ( 186000 - 62000 - 49000) (1-0.5) +49000 = 37500 + 49000 = 86500

After tax operating cashflow in year 2 = ( 186000 - 62000 - 49000) (1-0.5) +49000 = 37500 + 49000 = 86500

other out flow in year 1 = networking capital = 12000

Total cashflow in year 1 = operating CF - Working capital = 86500 - 12000 = 74500

where,

S = sales = revenue

C = Cost

D = Depreciation

T = tax rate

Terminal year after-tax non operating cash flow = Sal T + NWCinv - T(Sal T - BT) = 16000 + 28000 - 0.5(16000 - 2000) = 16000 +28000 -0.5(14000) = 16000+28000- 7000 = 37000

where,

Sal T = salvage value at time T

NWCinv = net working capital investment = 16000+ 12000 = 28000

BT = Book value at time T = initial investment - total depreciation = 100000 - 98000 = 2000

T = tax rate

Cash flow
initial at year 0	-116000
total CF in year 1	74500
Total CF in year 2	123500

Find Total Pv of CF

Year	Cash flow	Present value
1	74500	63642.58
2	123500	90125.96
Total		153768.54

Present value = CF / (1+R)n

where,

CF = cash flow

R = discount rate

n = no of year

Net present value = Total present value - initial investment = 153768.54 - 116000 = 37768.54

Hence Net present value is 37768.54