Question

Sam Corp. is considering a new investment whose data are shown below. The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require some additional working capital that would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's life. What is the project's NPV? WAAC = 12%, tax rate = 35% (Hint: Cash flows are constant in Years 1 to 3.) Show work. Net investment in fixed assets (basis) $75,000 Required new working capital $15,000 Sales revenues, each year $75,000 Operating costs (excl. deprec.), each year $25,000 a. $21,771.10 b. $30,025 c. $29,000.35 d. $19,752.24

Answer 1

The project's NPV  = d. $19,752.24 ,

Cash inflow per year :

  Sales revenues = $75000

less:Operating costs (excl. deprec.) = $25,000

less: Depreciation = 25000

Earning before interest and tax = 25000

less: tax rate @35% = 8750

Net income = 16250

Add :  Depreciation = 25000

  Cash inflow per year = $41250

Present value of cash inflow :

   Year Cash inflow PVAF(12%, 3 years) PVF (12%, 3 year) Present value

1-3    $41250 2.4018 - 99074.25

3 15000 - 0.7118   10677   

   $109751.25

Present value of cash outflow = Net investment in fixed assets (basis) of $75000 + Required new working capital of $15,000

   =$90000

Project's NPV = present value of cash inflow - present value of cash outflow

   =  $109751.25 - $90000

= $19751.25 ( rounded off to $19,752.24)

Note:- Depreciated on a straight-line basis  = Net investment in fixed assets  / useful life

   = $75,000  / 3

= $25000