Question

xyz is evaluating the reno proejct. the project requires an intial investment of 136,000 that would be depreciated to 16,000 over 6 years using the straight-line depreciation. the projec is expected to have operating cash flows of 51,000 per year forever. xyz expects the project to have an after tax terminal value of 186,000 in 3 years. the tax rate is 30% what is (X+Y)/Z if the x is the projects relevant expected cash flow in 3 years, Y is the projects relevant cash flow in year 4, and Z is the projects relevant expected cash flow in year 2?

Answer 1

The initial investment of the project = 136000

Salvage value at the end of 6 months = 16000

The amount of depreciation per year = Investment-Salvage Value/ No. of years

= 136000-16000/6 = 20000

The expected operating cash flow of the project = 51000

Terminal Value of the project = 186000 after 3 years

Tax Rate = 30%.

The question above, requires us to calculate the value of (X+Y)/Z, where X is the relevant expected cash flow in 3 years,Y is relevant cash flow in year 4 and Z is the cash flow in year 2

Assuming the discounting factor for the company = 10%

Calculation of the Net Cash Flows is as follows:

Year	Operating Cash Flow (A)	Depreciation (B)	Tax Amount (C) [(A-B) *30%]	Net Cash Flow (D) (A-B-C)	Discounted Factor @ 10%	Net Cash Flow after Discounting
1	51000	16000	10500	24500	0.909 (1/1.1)	22271
2	51000	16000	10500	24500	0.826 [(1/1.1)^2]	20237
3	51000	16000	10500	24500	0.751	18400
4	51000	16000	10500	24500	0.683	16734
5	51000	16000	10500	24500	0.621	15215
6	51000	16000	10500	24500	0.564	13818

Therefore, from the above the answer to the equation will be:

X+Y/Z = 18400+16734/20237 = 1.736

=> The above question can also be solved, without taking the assumption of the discounting factor, in that case the above equation will be solved as:

24500+24500/24500 = 2