Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.94 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 $2,160,000 in annual sales, with costs of $855,000. The project requires an initial investment in net working capital of $380,000, and the fixed asset will have a market value of $250,000 at the end of the project. If the tax rate is 34 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3?

Answer 1

	Year		0	1	2	3
A	Fixed asset cost		(2,940,000)
B	Working capital		(380,000)			380000
	Operating cash flow
i	sales			2,160,000	2,160,000	2,160,000
ii	Cost			855000	855000	855000
iii	Depreciation =2940000/3			980000	980000	980000
iv=i-ii-iii	Profit before tax			325,000	325,000	325,000
v=iv*34%	Tax @ 34%			110,500	110,500	110,500
vi=iv-v	Profit after tax			214,500	214,500	214,500
vii	Depreciation			980000	980000	980000
C=viii=vi+vii	Operating cash flow			1,194,500	1,194,500	1,194,500
D	Post tax salvage value =250000*(1-34%)					165000
E=A+B+C+D	Total cash flow		(3,320,000)	1,194,500	1,194,500	1,739,500
	therefore Answer -
	0	(3,320,000)
	1	1,194,500
	2	1,194,500
	3	1,739,500
Computation of NPV
	year	Cash flow	PVIF @ 10%	present value
	0	(3,320,000)	1.0000	(3,320,000.00)
	1	1,194,500	0.9091	1,085,909.09
	2	1,194,500	0.8264	987,190.08
	3	1,739,500	0.7513	1,306,912.10
				60,011.27
	therefore NPV =	60,011.27