Question

Problem 9-12 NPV and MACRS [LO 2]

H. Cochran Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2,410,000. The fixed asset falls into the three-year MACRS class (MACRS schedule). The project is estimated to generate $1,775,000 in annual sales, with costs of $672,000. The project requires an initial investment in net working capital of $380,000, and the fixed asset will have a market value of $375,000 at the end of the project.

a. If the tax rate is 23 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to two decimal places, e.g., 32.16.)

b. If the required return is 9 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to two decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $2,410,000
Useful Life = 3 years

Depreciation Year 1 = 33.33% * $2,410,000
Depreciation Year 1 = $803,253

Depreciation Year 2 = 44.45% * $2,410,000
Depreciation Year 2 = $1,071,245

Depreciation Year 3 = 14.81% * $2,410,000
Depreciation Year 3 = $356,921

Book Value at the end of Year 3 = $2,410,000 - $803,253 - $1,071,245 - $356,921
Book Value at the end of Year 3 = $178,581

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $375,000 - ($375,000 - $178,581) * 0.23
After-tax Salvage Value = $329,823.63

Initial Investment in NWC = $380,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$2,410,000 - $380,000
Net Cash Flows = -$2,790,000

Year 1:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($1,775,000 - $672,000) * (1 - 0.23) + 0.23 * $803,253
Operating Cash Flow = $1,034,058.19

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,034,058.19

Year 2:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($1,775,000 - $672,000) * (1 - 0.23) + 0.23 * $1,071,245
Operating Cash Flow = $1,095,696.35

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,095,696.35

Year 3:

Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($1,775,000 - $672,000) * (1 - 0.23) + 0.23 * $356,921
Operating Cash Flow = $931,401.83

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $931,401.83 + $380,000 + $329,823.63
Net Cash Flows = $1,641,225.46

Answer b.

Required Return = 9%

NPV = -$2,790,000 + $1,034,058.19/1.09 + $1,095,696.35/1.09^2 + $1,641,225.46/1.09^3
NPV = $348,230.12