Question

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.85 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 $2,130,000 in annual sales, with costs of $825,000. The project requires an initial investment in net working capital of $350,000, and the fixed asset will have a market value of $235,000 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?

If the required return is 11 percent, what is the project's NPV?

Answer 1

The NPV of the project is $63,657.3

EXPLANATIONS: -

A). Initial investment of the project at year 0 is $3,200,000

cash flow (year 0) = cost of new equipment + increase in Net working capital

1. cost of new fixed assets = $2,850,000

2.increase in Net working capital = $350,000

cash flow (year 0) = ($2,850,000+ $350,000) = $3,200,000

B). Yearly after-tax operating Cash Flow for year 1 and 2 is $1,184,300

Annual revenue	$2,130,000
Decrease in Expenses	($825,000)
Depreciation ( $2,850,000 / 3)	($950,000)
Earnings before tax	$355,000
Taxes (34%)	($120,700)
Earnings after tax	$234,300
Add non-cash expense (depreciation)	$950,000
Yearly operating Cash Flow	$1,184,300

C). Net cash flow of the project at year 3 is $1,689,400

Net cash flow of the project at year 3 = operating cash flow of year 3 + NSV of project assets + Recovered Net working capital

1. Operating cash flow of year 3 = $1,184,300

2. NSV of project assets = market value of asset * (1- tax rate)

     = $235,000 * (1-.34)

      =$155,100

2.Recovered Net working capital = $350,000

Therefore, Net cash flow of the project at year 3 = $1,184,300 + $155,100 +$350,000= $1,689,400

D. NPV CALCULATIONS: -

NPV = after-tax operating cash flows from year 1 and 2 *(PVIFA. 11%,2 years) + Net cash flow of the project at year 3 * (PVIF.11%, year 3)- initial investment

NPV= ($1,184,300 * 1.713) + ($1,689,400 * 0.731) -$3,200,000

NPV=    $2,028,705.9 + $1,234,951.4 - $3,200,000

NPV = $63,657.3