Question

XYZ is considering a five-year project that will require $738,000 for new fixed assets that will be depreciated straight-line to a zero book value over five years. No bonus depreciation will be taken. At the end of the project, the fixed assets can be sold for 18 percent of their original cost. The project is expected to generate annual sales of $679,000 with costs of $321,000. The tax rate is 22 percent and the required rate of return is 15.2 percent. Should the project be accepted?

Answer 1

We need to calcualte the NPV of the project:

Particulars	Remark	0	1	2	3	4	5
Sales	Given		$      6,79,000.00	$      6,79,000.00	$      6,79,000.00	$      6,79,000.00	$      6,79,000.00
Total VC	Given		$      3,21,000.00	$      3,21,000.00	$      3,21,000.00	$      3,21,000.00	$      3,21,000.00
EBITDA	Sales-Total VC-Fixed Cost		$      3,58,000.00	$      3,58,000.00	$      3,58,000.00	$      3,58,000.00	$      3,58,000.00
Depreciation	738000/5 = 147600		$      1,47,600.00	$      1,45,000.00	$      1,45,000.00	$      1,45,000.00	$      1,45,000.00
EBT	EBITDA-Depreciation		$      2,10,400.00	$      2,13,000.00	$      2,13,000.00	$      2,13,000.00	$      2,13,000.00
Tax	22% x EBT		$          46,288.00	$          74,550.00	$          74,550.00	$          74,550.00	$          74,550.00
EAT	EBT-Tax		$      1,64,112.00	$      1,38,450.00	$      1,38,450.00	$      1,38,450.00	$      1,38,450.00
Depreciation	Added back as non cash		$      1,47,600.00	$      1,45,000.00	$      1,45,000.00	$      1,45,000.00	$      1,45,000.00
OCF	EAT+Depreciation		$      3,11,712.00	$      2,83,450.00	$      2,83,450.00	$      2,83,450.00	$      2,83,450.00
FCINV	Given	$    -7,38,000.00
Salvage value	18% x 738000						$      1,32,840.00
Tax on profit on salvage value	0.22 x 18% x 738000						$ 29,224.80
FCF	OCF+FCINV+Salvage value- tax on profit	$    -7,38,000.00	$      3,11,712.00	$      2,83,450.00	$      2,83,450.00	$      2,83,450.00	$      3,87,065.20
Discount factor Formula	at 15.2 %	1/(1+0.152)^0	1/(1+0.152)^1	1/(1+0.152)^2	1/(1+0.152)^3	1/(1+0.152)^4	1/(1+0.152)^5
Discount factor	Calculated using above formula	1	0.868055556	0.753520448	0.654097611	0.567793065	0.492875924
DCF	FCF x Discount Factor	$    -7,38,000.00	$      2,70,583.33	$      2,13,585.37	$      1,85,403.97	$      1,60,940.94	$      1,90,775.12
NPV = sum of all DCF	$                           2,83,288.73

• As the fixed asset is depreciated to 0 and sold at 18% of the cost, the entire salvage value is profit.
• Profit is taxed and is an outflow
• As NPV is positive so the project should be accepted