Question

Gateway Communications is considering a project with an initial fixed assets cost of $1.57 million that will be depreciated straight-line to a zero book value over the 9-year life of the project. At the end of the project the equipment will be sold for an estimated $238,000. The project will not change sales but will reduce operating costs by $395,000 per year. The tax rate is 35 percent and the required return is 11.3 percent. The project will require $51,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Answer 1

Computation of annual cash flow:

Cost saving	$395,000
Less: Depreciation ($1,570,000/9)	174,444.4444
Savings before tax	220,555.5556
Less: Tax @ 35 %	77,194.44444
Net savings	14,3361.1111
Add: Depreciation	174,444.4444
Net annual cash flow	$317,805.5556

Initial cost = Cost of assets + Working capital = $ 1,570,000 + $ 51,000 = $ 1,621,000

Final year cash flow = Net annual cash flow + Working capital + After tax salvage value

                                     = $ 317,805.5556 + $ 51,000 + $ 238,000 x (1-0.35)

                                     = $ 317,805.5556 + $ 51,000 + $ 238,000 x 0.65

                                     = $ 317,805.5556 + $ 51,000 + $ 154,700

                                    = $ 523,505.5556

Computation of NPV:

NPV = PV of cash inflows – Initial investment

Year	Cash Flow C	Computation of PV Factor	PV Factor @ 11.3 % (F)	PV (C x F)
0	-$1,621,000	1/(1+0.113)^0	1	-$1,621,000
1	317,805.5556	1/(1+0.113)^1	0.89847259658580	285,539.5827
2	317,805.5556	1/(1+0.113)^2	0.80725300681564	256,549.4903
3	317,805.5556	1/(1+0.113)^3	0.72529470513534	230,502.6867
4	317,805.5556	1/(1+0.113)^4	0.65165741701289	207,100.3475
5	317,805.5556	1/(1+0.113)^5	0.58549633154797	186,073.9869
6	317,805.5556	1/(1+0.113)^6	0.52605240929737	167,182.3782
7	317,805.5556	1/(1+0.113)^7	0.47264367412162	150,208.7855
8	317,805.5556	1/(1+0.113)^8	0.42465738914791	134,958.4775
9	523505.5556	1/(1+0.113)^9	0.38154302708707	199,739.8944
			NPV	$196,855.6298

NPV of the project is $ 196,855.63