Question

Green Forest Technology is considering a project that would last for 2 years. The project would involve an initial investment of 76,000 dollars for new equipment that would be sold for an expected price of 77,000 dollars at the end of the project in 2 years. The equipment would be depreciated to 22,000 dollars over 6 years using straight-line depreciation. In years 1 and 2, relevant annual revenue for the project is expected to be 65,000 dollars per year and relevant annual costs for the project are expected to be 28,000 dollars per year. The tax rate is 50 percent and the cost of capital for the project is 5.27 percent. What is the net present value of the project?

Answer 1

Time line		0	1	2
Cost of new machine		-76000
=Initial Investment outlay		-76000
					100.00%
Sales			65000	65000
Profits	Sales-variable cost		37000	37000
-Depreciation	(Cost of equipment-salvage value)/no. of years		-16333.3	-16333.3	43333.333	=Salvage Value
=Pretax cash flows			20666.67	20666.67
-taxes	=(Pretax cash flows)*(1-tax)		10333.33	10333.33
+Depreciation			16333.33	16333.33
=after tax operating cash flow			26666.67	26666.67
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)			38500
+Tax shield on salvage book value	=Salvage value * tax rate			21666.67
=Terminal year after tax cash flows				60166.67
Total Cash flow for the period		-76000	26666.67	86833.33
Discount factor=	(1+discount rate)^corresponding period	1	1.0527	1.108177
Discounted CF=	Cashflow/discount factor	-76000	25331.69	78356.9
NPV=	Sum of discounted CF=	27688.58