Question

ABC Corporation has hired you to evaluate a new FOUR year project for the firm. The project will require the purchase of a $769,500.00 work cell. Further, it will cost the firm $55,900.00 to get the work cell delivered and installed. The work cell will be straight-line depreciated to zero with a 20-year useful life. The project will require new employees to be trained at a cost of $62,300.00. The project will also use a piece of equipment the firm already owns. The equipment has been fully depreciated, but has a market value of $6,200.00. Finally, the firm will invest $10,200.00 in net working capital to ensure the project has sufficient resources to be successful.

The project will generate annual sales of $912,000.00 with expenses estimated at 39.00% of sales. Net working capital will be held constant throughout the project. The tax rate is 36.00%.​

The work cell is estimated to have a market value of $456,000.00 at the end of the fourth year. The firm expects to reclaim 82.00% of the final NWC position.​

The cost of capital is 12.00%.​

​

What is the cash flow to start the project in year 0?

What is the yearly operating cash flow for the project?

What is the terminal cash flow for the project?

What is the NPV the project if we end the project after 4 years?

Answer 1

Answer.

Calculation of cash flow at the start of project in year 0

Particulars	Amount ($)
Purchase Cost of work cell	7,69,500
Installation Cost	55,900
Employee Training Cost	62,300
Opportunity Cost of Equipment	6,200
Working Capital	10,200
Total	9,04,100

So Initial Cost of Project at the year Zero= $904,100 (Ans)

Answer(b)

Total Cost of Machine=(Purchase Cost+Installation Cost )=(769500+55900)=$825400

Life of Machine= 20 years

Depreciation=$825,400/20= $41,270/

Statement of Computation of Operating Cash Flow:-

Particulars	Amount ($)
Annual Sales	912000
Less:- Expenses @39% of Sales	355680
Less:- Depreciation	41270
EBIT	515050
Less:- Tax @36%	185418
Net Income	329632
Add:- Depreciation	41270
Annual Operating Cash Flow	370902

Yearly Operating Cash Flow of Project $370,902 till the end of four years..

Answer(c)

As we know that Terminal Cash Flow = After Tax sale proceeds from disposal of Assets+ Working Capital Recoverable

Now,

Book Value of Work Cell= Initial Cost - Depreciation Claimed

= 825400-4*41270= $660,320

Market Value of Work Cell at the end of Fourth year= $456,000/-

Loss on disposal of Work Cell= Sale Proceeds -Book Value

= $456000-$660320=-$204,320

It is assumed that tax is saved on the disposal loss of work cell

So,Tax saved on loss= -204320*0.36= $73,555

Net Cashflow= 456000+73555=$529,555

Net Working Capital Recovered= 82% of Initial Working Capital= 0.82*10200=$8,364

So,Total Terminal Cash Flow From The Project= (529555+8364)= $537,919 (Answer)

Answer (d)

Cost of Capital = 12%

NPV = -Initial Cash Outflow+PV of Operating Cash Flow+PV of Terminal Cash Flow

NPV= -940100+370902* PVIFA(12%,4)+537919*PVIF(12%,4)

NPV=-940100+370902*3.0373+537919*0.6355

NPV=-940100+1,126,559+341,857=$564,316 (Answer)

Note:-

*Tax amount on opportunity cost of equipment whose book value is zero has been ignored

**While calculating the after tax sale proceeds from disposal of assets it is assumed that company has another department which would setoff this loss against the profit of another department so the tax on this loss is being adjusted.

***2nd method for PV of Annual Cash Flow :-

Year	1	2	3	4	Total
D.F.@12%	0.892857	0.797194	0.71178	0.635518
Annual cash Flow	370902	370902	370902	370902
Discounted Cash Flow	331162.5	295680.8	264000.7	235714.9	1126559