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

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 1 year ago

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