Question

Heron Corporation is planning to add manufacturing capacity by installing new high-tech machines. The machines would increase revenues by $180,000 per year and increase costs by $50,000 per year. The new machines cost $560,000 and would be depreciated over 5 years using simplified straight line. Investment in net working capital of $30,000 would be required at the time of installation. The firm is planning to keep the machines for 7 years and then sell them for $80,000. The firm has a required rate of return on investment projects of 13% and a marginal tax rate of 34%. What is the net present value of this project? Please show work without using the excel format.

  

$283,800

  

$34,234

  

$54,161

  

$45,458

$41,409

Answer 1

Answer :

Initial investment = $560,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $560,000 / 5
Annual Depreciation = $112,000

Initial Investment in NWC = $30,000

Salvage Value = $80,000

After-tax Salvage Value = $80,000 * (1 - 0.34)
After-tax Salvage Value = $52,800

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$560,000 - $30,000
Net Cash Flows = -$590,000

For Year 1 to Year 5:

Operating Cash Flow = (Incremental Sales - Incremental Costs) * (1 - tax) + tax * Depreciation
Operating Cash Flow = ($180,000 - $50,000) * (1 - 0.34) + 0.34 * $112,000
Operating Cash Flow = $123,880

For Year 6:

Operating Cash Flow = (Incremental Sales - Incremental Costs) * (1 - tax)
Operating Cash Flow = ($180,000 - $50,000) * (1 - 0.34)
Operating Cash Flow = $85,800

For Year 7:

Operating Cash Flow = (Incremental Sales - Incremental Costs) * (1 - tax)
Operating Cash Flow = ($180,000 - $50,000) * (1 - 0.34)
Operating Cash Flow = $85,800

Net Cash Flow = Operating Cash Flow + Investment in NWC recovered + After-tax Salvage Value
Net Cash Flow = $85,800 + $30,000 + $52,800
Net Cash Flow = $168,600

Required return = 13%

NPV = -$590,000 + $123,880/1.13 + $123,880/1.13^2 + $123,880/1.13^3 + $123,880/1.13^4 + $123,880/1.13^5 + $85,800/1.13^6 + $168,600/1.13^7
NPV = -$41,409

NPV of the project is ( $41,409 ).