Question

Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.31 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $1,770,000 in annual sales, with costs of $680,000. The project requires an initial investment in net working capital of $370,000, and the fixed asset will have a market value of $360,000 at the end of the project.

a.	If the tax rate is 22 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.)
b.	If the required return is 12 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

a)

Year 0 cash flow = -fixed investment - increase in NWC

Year 0 cash flow = -2,310,000 - 370,000

Year 0 cash flow = -2,680,000

b)

Annual depreciation = 2,310,000 / 3

Annual depreciation = 770,000

Year 1 cash flow = (Sales - costs - depreciation)(1 - tax) + depreciation

Year 1 cash flow = (1,770,000 - 680,000 - 770,000)(1 - 0.22) + 770,000

Year 1 cash flow = 249,600 + 770,000

Year 1 cash flow = 1,019,600

c)

Year 2 cash flow = 1,019,600

d)

Non operating year 3 cash flow = Market value + Recovery of NWC - tax(market value - book value)

Non operating year 3 cash flow = 360,000 + 370,000 - 0.22(360,000 - 0)

Non operating year 3 cash flow = 360,000 + 370,000 - 79,200

Non operating year 3 cash flow = 650,800

Year 3 cash flow = 1,019,600 + 650,800

Year 3 cash flow = 1,670,400

e)

NPV = Present value of cash inflows - present value of cash outflows

NPV = -2,680,000 + 1,019,600 / (1 + 0.12)^1 + 1,019,600 / (1 + 0.12)^2 + 1,670,400 / (1 + 0.12)^3

NPV = $232,134