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In: Finance
Cocharen inc. is considering a new three-year expansion project that requires an initial fixed asset investment...
Cocharen inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $2,160,000. The fixed assets will be depreciated with bonus depreciation. At the end of the project's three-year life, the fixed asset is expected to be worthless. The project is estimated to generate $2,170,000 in annual sales, with operating costs of $1,160,000 per year. The firm's tax rate is 21% and the required return on the project is 11%. What is the project's payback period?
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Expert Solution
| Calculation of cash flows | |||||||
| Year 0 | Year 1 | Year 2 | Year 3 | ||||
| Initial investment | -2160000 | - | - | - | |||
| Sales | - | 2170000.00 | 2170000.00 | 2170000.00 | |||
| Less : Operating cost | - | -1160000.00 | -1160000.00 | -1160000.00 | |||
| Less : Bonus depreciation allowed | - | -2160000.00 | 0.00 | 0.00 | |||
| in year 1 | ___________ | _____________________________________ | |||||
| Annual Profit | - | -1150000.00 | 1010000.00 | 1010000.00 | |||
| Less : Tax | 21% | 241500.00 | -212100.00 | -212100.00 | |||
| ___________ | _____________________________________ | ||||||
| Profits after tax | -885000.00 | 797900.00 | 797900.00 | ||||
| Add : Depreciation (non-cash exp.) | |||||||
| (considered only for tax Purpose, so added back) | 2160000.00 | - | - | ||||
| ___________ | _____________________________________ | ||||||
| Cash flow | -2160000 | 1275000.00 | 797900.00 | 797900.00 | |||
| Cumulative cash flows | -2160000 | -885000.00 | -87100.00 | 710800.00 | |||
| ______________________________________________ | |||||||
| Payback period is period ot time, at which full value of investment is recovered. | |||||||
| Payback formula = Year in which cum. Cash flow become positive - (Cumulative cash flow of that year / Cash flow of that year | |||||||
| 4 Years - (710800/797900) | |||||||
| 3.109161549 | |||||||
| So, payback period of project is 3.11 Years. | |||||||
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