Question

Scott Milton, the chief executive officer of Route Corporation, has assembled his top advisers to evaluate an investment opportunity. The advisers expect the company to pay $420,000 cash at the beginning of the investment and the cash inflow for each of the following four years to be the following:

Year 1 $87,000 Year 2 $105,000 Year 3 $122,000 Year 4 $187,000

Mr. Milton agrees with his advisers that the company should use the discount rate (required rate of return) of 10 percent to compute net present value to evaluate the viability of the proposed project. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required a. Determine the net present value of the proposed project.

b.&c. Kent Howe, one of the advisers, is wary of the cash flow forecast and he points out that the advisers failed to consider that the depreciation on equipment used in this project will be tax deductible. The depreciation is expected to be $84,000 per year for the four-year period. The company’s income tax rate is 35 percent per year. Use this information to revise the company’s expected cash flow from this project. Determine the net present value of the project based on the revised cash flow forecast.

Answer 1

Solution a:

Computation of NPV
Particulars	Period	PV Factor @10%	Amount	Present Value
Cash outflows:
Initial Investment Cost	0	1	$420,000.00	$420,000.00
Present Value of Cash outflows (A)				$420,000.00
Cash Inflows
Year 1	1	0.909090909	$87,000.00	$79,090.91
Year 2	2	0.826446281	$105,000.00	$86,776.86
Year 3	3	0.751314801	$122,000.00	$91,660.41
Year 4	4	0.683013455	$187,000.00	$127,723.52
Present Value of Cash Inflows (B)				$385,251.69
Net Present Value (NPV) (B-A)				-$34,748.31

Since NPV is negative, therefore project is not Viable.

Solution b&c:

Computation of Revised cash Inflows
Year	Cash Inflows	Depreciation Tax Benefit (Depreciation* 35%)	Revised Cash Inflows
1	$87,000.00	29400	$116,400.00
2	$105,000.00	29400	$134,400.00
3	$122,000.00	29400	$151,400.00
4	$187,000.00	29400	$216,400.00

Computation of NPV based on revised Cash Flows
Particulars	Period	PV Factor @10%	Amount	Present Value
Cash outflows:
Initial Investment Cost	0	1	$420,000.00	$420,000.00
Present Value of Cash outflows (A)				$420,000.00
Cash Inflows
Year 1	1	0.909090909	$116,400.00	$105,818.18
Year 2	2	0.826446281	$134,400.00	$111,074.38
Year 3	3	0.751314801	$151,400.00	$113,749.06
Year 4	4	0.683013455	$216,400.00	$147,804.11
Present Value of Cash Inflows (B)				$478,445.73
Net Present Value (NPV) (B-A)				$58,445.73