Question

Cavendish Corporation had embarked on an exciting new project, but is re-evaluating the project after a rocky start.

Unfortunately, the contractor working on the original equipment has gone broke and will be unable to complete the assembly of the equipment. To date $200,000 in progress payments have been made and will not be recoverable. These costs have been expensed. However, with in-house expertise the equipment for the project could be completed almost immediately at a further cost of $750,000.

If the project proceeds, an overhaul of the equipment will be required at the end of year 4 for $325,000. All the equipment could be salvaged for $50,000 when the project is completed at the end of year 9.

The equipment will be put into use immediately, but will not begin to generate revenue until year 2. During year 1, cash expenses of $250,000 will be incurred. The project will generate yearly revenues of $560,000 for years 2 – 9 inclusive. Cash expenses would be $200,000 per year for years 2 – 9 inclusive.

If they embark on this project, Cavendish Corporation will need to increase its inventory and accounts receivable [working capital] by $40,000, immediately.

CCA Rate: 30%

Tax Rate: 35%

WACC: 12.5%

1. Calculate the PV of all of the INFLOWS related to this project, excluding the PV CCA.  

2. Calculate the PV of all of the OUTFLOWS related to this project.  

3. Calculate the PV CCA for the above question.

4. Calculate the TOTAL NPV of the proposed project.

5. Should the company proceed with the project based on the NVP Analysis? Yes / No

Answer 1

1. PV of inflows excluding PV CCA = +25,06,104

2 PV of outflows = -930,896

3 PV of CCA (Tax savings on depreciation): 228,155

4. NPV including depreciation tax save: 1,803,363

5. Yes, as the NPV is positive

Workings:

Without depreciation

	cost of equipment+working capital	cash expenses	revenues	Salvage value	Net revenue	Tax expense/saving	After tax revenue	Discount rate @ 12.5%	Net present value
0	-790000	-2,50,000.00			-10,40,000	3,12,000	-7,28,000	1	-7,28,000
1		2,00,000.00			2,00,000	-60,000	1,40,000	0.888888889	1,24,444
2		2,00,000.00	5,60,000.00		7,60,000	-2,28,000	5,32,000	0.790123457	4,20,346
3		2,00,000.00	5,60,000.00		7,60,000	-2,28,000	5,32,000	0.702331962	3,73,641
4	-325000	2,00,000.00	5,60,000.00		4,35,000	-1,30,500	3,04,500	0.624295077	1,90,098
5		2,00,000.00	5,60,000.00		7,60,000	-2,28,000	5,32,000	0.554928957	2,95,222
6		2,00,000.00	5,60,000.00		7,60,000	-2,28,000	5,32,000	0.493270184	2,62,420
7		2,00,000.00	5,60,000.00		7,60,000	-2,28,000	5,32,000	0.438462386	2,33,262
8		2,00,000.00	5,60,000.00		7,60,000	-2,28,000	5,32,000	0.389744343	2,07,344
9		2,00,000.00	5,60,000.00	50,000.00	8,10,000	-2,43,000	5,67,000	0.346439416	1,96,431
									15,75,208

Including Depreciation

	Value of equipment_Beginning	Depreciation @ 30%	Value of equipment_ending	After tax revenue	Add Tax save on Depreciation	Discount rate @ 12.5%	Net present value
0	750000			-7,28,000	-7,28,000	1	-7,28,000
1	750000	225000	525000	1,40,000	218750	0.888888889	1,94,444
2	525000	157500	367500	5,32,000	587125	0.790123457	4,63,901
3	367500	110250	257250	5,32,000	570588	0.702331962	4,00,742
4	257250	77175	180075	3,04,500	331511	0.624295077	2,06,961
5	505075	151523	353553	5,32,000	585033	0.554928957	3,24,652
6	353553	106066	247487	5,32,000	569123	0.493270184	2,80,731
7	247487	74246	173241	5,32,000	557986	0.438462386	2,44,656
8	173241	51972	121269	5,32,000	550190	0.389744343	2,14,434
9	121269	36381	84888	5,67,000	579733	0.346439416	2,00,842
	Year 5 beginning value - Add 325k additional cost					18,03,363