Kennedy Air is evaluating a new project. The equipment will cost $70,000 plus $8,000 to install....

Kennedy Air is evaluating a new project. The equipment will cost $70,000 plus $8,000 to install. It will be depreciated using the MACRS 3-year class. The project would require an increase in inventories of $5,000 and an increase in A/P of $3,000. The firm’s yearly revenues would increase by $70,000 but would also increase operating costs by $20,000. The project is expected to last 3 years and the equipment can then be sold for $12,000. The firm’s tax rate is 40% and their cost of capital is 10%. What is the project’s NPV?

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Expert Solution

Working capital = inventories-increase in A/P = 5000-3000=2000

Time line		0	1	2	3



Cost of new machine		-78000
Initial working capital		-2000
=Initial Investment outlay		-80000

3 years MACR rate			33.33%	44.45%	14.81%	7.41%
Sales			70000	70000	70000
Profits	Sales-variable cost		70000	70000	70000

Operating cost			-20000	-20000	-20000
-Depreciation	=Cost of machine*MACR%		-25997.4	-34671	-11551.8	5779.8	=Salvage Value

=Pretax cash flows			24002.6	15329	38448.2
-taxes	=(Pretax cash flows)*(1-tax)		14401.56	9197.4	23068.92
+Depreciation			25997.4	34671	11551.8
=after tax operating cash flow			40398.96	43868.4	34620.72

reversal of working capital					2000

+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				7200
+Tax shield on salvage book value	=Salvage value * tax rate				2311.92
=Terminal year after tax cash flows					11511.92

Total Cash flow for the period		-80000	40398.96	43868.4000	46132.64
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-80000	36726.32727	36254.87603	34660.13524
NPV=	Sum of discounted CF=	27641.34

jeff jeffy answered 1 year ago

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