Question

Silver Sun Media is considering a project that would last for 2 years. The project would involve an initial investment of 104,000 dollars for new equipment that would be sold for an expected price of 84,000 dollars at the end of the project in 2 years. The equipment would be depreciated to 24,000 dollars over 4 years using straight-line depreciation. In years 1 and 2, relevant annual revenue for the project is expected to be 85,000 dollars per year and relevant annual costs for the project are expected to be 29,000 dollars per year. The tax rate is 50 percent and the cost of capital for the project is 4.39 percent. What is the net present value of the project?

Answer 1

Time line		0	1	2
Cost of new machine		-104000
=Initial Investment outlay		-104000
					100,00%
Sales			85000	85000
Profits	Sales-variable cost	56000	56000
-Depreciation	(Cost of equipment-salvage value)/no. of years	-20000	-20000	64000	=Salvage Value
=Pretax cash flows			36000	36000
-taxes	=(Pretax cash flows)*(1-tax)	18000	18000
+Depreciation			20000	20000
=after tax operating cash flow			38000	38000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)		42000
+Tax shield on salvage book value	=Salvage value * tax rate		32000
=Terminal year after tax cash flows				74000
Total Cash flow for the period		-104000	38000	112000
Discount factor=	(1+discount rate)^corresponding period	1	1,0439	1,08972721
Discounted CF=	Cashflow/discount factor	-104000	36401,95421	102778,0154
NPV=	Sum of discounted CF=	35179,97