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HMS Corporation is considering an expansion project that requires investment in capital assets of $545,000, costs...

  1. HMS Corporation is considering an expansion project that requires investment in capital assets of $545,000, costs of $15,000 to modify the assets before they can be put into operation, and additional raw materials inventory of $50,000 to support the project. In addition, HMS had spent $25,000 to study the viability of this project. The one-time after-tax opportunity costs associated with this project are $36,000. The project is expected to generate operating revenue of $600,000 per year, and the associated operating expenses are estimated at $275,000 per year. The capital assets belong to asset class 9, which has a CCA rate of 30 percent. The assets are expected to sell for $42,000 when the project terminates in eight years. Assume the asset class remains open after the project terminates. The firm’s cost of capital is 14 percent and marginal tax rate is 40 percent.

a) What is the initial after-tax cash flow?

b) What is the present value of the CCA tax savings?

c) What is the present value of the after-tax operating cash flows?

d) What is the ending after-tax cash flow?

e) What is the NPV of the project?

Solutions

Expert Solution

a) Statement showing initial after-tax cash flow

Particulars Amount
Cost of capital asset -545000
Modification cost -15000
Increase in inventory -50000
One time after tax opportunity cost -36000
Initial after-tax cash flow -646000

b) Statement showing depreciation

Year Opening balance Depreciation Rates Depreciation
(opening balance x Depreciation rates)		 Closing Balance
1 560000 15% 84000 476000
2 476000 30% 142800 333200
3 333200 30% 99960 233240
4 233240 30% 69972 163268
5 163268 30% 48980 114288
6 114288 30% 34286 80001
7 80001 30% 24000 56001
8 56001 30% 16800 39201

Statement showing PV of tax shield

Year Depreciation Tax Shield @ 40% PVIF @ 14% PV
1 84000 33600 0.8772 29473.68
2 142800 57120 0.7695 43951.99
3 99960 39984 0.6750 26988.06
4 69972 27989 0.5921 16571.62
5 48980 19592 0.5194 10175.55
6 34286 13715 0.4556 6248.15
7 24000 9600 0.3996 3836.58
8 16800 6720 0.3506 2355.80
PV of tax shield 139601.43

c) Statement showing PV of after tax operating cash flow

Particulars 1 2 3 4 5 6 7 8 Total
Cost of capital asset
Modification cost
Increase in inventory
One time after tax opportunity cost
Operating revenue 600000 600000 600000 600000 600000 600000 600000 600000
Operating expenses -275000 -275000 -275000 -275000 -275000 -275000 -275000 -275000
Depreciation -84000 -142800 -99960 -69972 -48980 -34286 -24000 -16800
PBT 241000 182200 225040 255028 276020 290714 301000 308200
Tax @ 40% 96400 72880 90016 102011 110408 116285 120400 123280
PAT 144600 109320 135024 153017 165612 174428 180600 184920
Add: Depreciation 84000 142800 99960 69972 48980 34286 24000 16800
Annual after tax cash flow 228600 252120 234984 222989 214592 208715 204600 201720
PVIF @ 14% 0.8772 0.7695 0.6750 0.5921 0.5194 0.4556 0.3996 0.3506
Present value of Annual after tax cash flow 200526 193998 158608 132027 111452 95088 81766 70715 1044180

d) Statement showing cash inflow from sale of asset

Particulars Amount
Selling price of asset at end of year 8 42000
Book value as at year 8 39201
Profit 2799
Tax @ 40% 1120
Cash inflow
(42000-1120)		 40880

Statement showing  ending after-tax cash flow

Particulars Amount
Cash inflow from sale of asset 40880
Release of WC 50000
Total after tax terminal cash flow 90880

e) Statement showing NPV

Particulars 0 1 2 3 4 5 6 7 8 Total
Cost of capital asset -545000
Modification cost -15000
Increase in inventory -50000
One time after tax opportunity cost -36000
Operating revenue 600000 600000 600000 600000 600000 600000 600000 600000
Operating expenses -275000 -275000 -275000 -275000 -275000 -275000 -275000 -275000
Depreciation -84000 -142800 -99960 -69972 -48980 -34286 -24000 -16800
PBT 241000 182200 225040 255028 276020 290714 301000 308200
Tax @ 40% 96400 72880 90016 102011 110408 116285 120400 123280
PAT 144600 109320 135024 153017 165612 174428 180600 184920
Add: Depreciation 84000 142800 99960 69972 48980 34286 24000 16800
Annual after tax cash flow 228600 252120 234984 222989 214592 208715 204600 201720
Release of WC 50000
Cash inflow from sale of asset 40880
Total Cash flow -646000 228600 252120 234984 222989 214592 208715 204600 292600
PVIF @ 14% 1 0.8772 0.7695 0.6750 0.5921 0.5194 0.4556 0.3996 0.3506
PV -646000 200526 193998 158608 132027 111452 95088 81766 102574 430039

Thus NPV = 430039$

jeff jeffy answered 2 years ago
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