Question

Maria is evaluating an idea to open her own business. The initial investment is 34 estimated to be $100,000. The investment horizon is 5 years. She will use a 5-year straight-line depreciation schedule, with an ending book value of zero for the assets. The salvage value for the assets at the end of the project is $20,000. The initial working capital requirement is $10,000 and the working capital remains to be $10,000 each year. Maria expects to generate the revenues of $80,000 with the costs of $30,000 each year during the 5-year time period. The tax rate is 20%. Compute the net present value (NPV) for this investment using the required return of 12%.

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-100000
Initial working capital		-10000
=Initial Investment outlay		-110000
Sales			80000	80000	80000	80000	80000
Profits	Sales-variable cost		50000	50000	50000	50000	50000
-Depreciation	Cost of equipment/no. of years		-20000	-20000	-20000	-20000	-20000
-working capital to be maintained			-10000	-10000	-10000	-10000	-10000
=Pretax cash flows			20000	20000	20000	20000	20000
-taxes	=(Pretax cash flows)*(1-tax)		16000	16000	16000	16000	16000
+Depreciation			20000	20000	20000	20000	20000
=after tax operating cash flow			36000	36000	36000	36000	36000
reversal of working capital							60000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						16000
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							76000
Total Cash flow for the period		-110000	36000	36000	36000	36000	112000
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928	1.57351936	1.7623417
Discounted CF=	Cashflow/discount factor	-110000	32142.85714	28698.9796	25624.0889	22878.6508	63551.808
NPV=	Sum of discounted CF=	62896.38432