Question

Quad Enterprises is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.43 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $189,000. The project requires an initial investment in net working capital of $270,000. The project is estimated to generate $2,160,000 in annual sales, with costs of $864,000. The tax rate is 25 percent and the required return on the project is 17 percent.

What is the project's Year 0 net cash flow?

What is the project's Year 1 net cash flow? What is the project's Year 2 net cash flow? What is the project's Year 3 net cash flow? What is the NPV?

Answer 1

Initial Investment = $2,430,000
Useful Life = 3 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $2,430,000 / 3
Annual Depreciation = $810,000

Initial Investment in NWC = $270,000

Salvage Value = $189,000

After-tax Salvage Value = $189,000 * (1 - 0.25)
After-tax Salvage Value = $141,750

Annual Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = ($2,160,000 - $864,000) * (1 - 0.25) + 0.25 * $810,000
Annual Operating Cash Flow = $1,296,000 * 0.75 + 0.25 * $810,000
Annual Operating Cash Flow = $1,174,500

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$2,430,000 - $270,000
Net Cash Flows = -$2,700,000

Year 1:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,174,500

Year 2:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,174,500

Year 3:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $1,174,500 + $270,000 + $141,750
Net Cash Flows = $1,586,250

Required return = 17%

NPV = -$2,700,000 + $1,174,500/1.17 + $1,174,500/1.17^2 + $1,586,250/1.17^3
NPV = $152,242.11