In: Finance
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 tax rate of 21%. What is the net present value of this project?
Cash Flows from Year 1 to Year 5 | |
Incremental Revenue | 180000 |
Less: Incremental Costs | 50000 |
Less: Depreciation (560000-80000)/5 | 96000 |
Income before taxes | 34000 |
Less: Taxes (54000*21%) | 7140 |
Net income | 26860 |
Add: Depreciation | 96000 |
Incremental Cash flows | 122860 |
Cash Flows from Year 6 & Year 7 | |
Incremental Revenue | 180000 |
Less: Incremental Costs | 50000 |
Less: Depreciation | 0 |
Income before taxes | 130000 |
Less: Taxes (150000*21%) | 27300 |
Net income | 102700 |
Add: Depreciation | 0 |
Incremental Cash flows | 102700 |
Net present value of the project | ||||
Year | Cash flows | PV factor @13% | Discounted cash flows | |
0 | Initial investment | -560000 | 1.000000 | -560000 |
0 | Net working capital | -30000 | 1.000000 | -30000 |
1 | Net Cash flows | 122860 | 0.884956 | 108726 |
2 | Net Cash flows | 122860 | 0.783147 | 96217 |
3 | Net Cash flows | 122860 | 0.693050 | 85148 |
4 | Net Cash flows | 122860 | 0.613319 | 75352 |
5 | Net Cash flows | 122860 | 0.542760 | 66683 |
6 | Net Cash flows | 102700 | 0.480319 | 49329 |
7 | Net Cash flows | 102700 | 0.425061 | 43654 |
7 | Salvage value | 80000 | 0.425061 | 34005 |
Net present value | -30885 |