Question

The table below offers EBIT for a potential capital investment for Fake Company Alpha. You should be able to determine a few things once you consider the following:

• The initial investment is $12,000.
• Depreciation is straight line over four years.
• The company's WACC is estimated at 8.5%.
• Company analysts estimate that a proper salvage value at the end of the project life of four years is 30% of the initial investment.
• The company's tax rate is 27.0%.

	YEAR 1	YEAR 2	YEAR 3	YEAR 4
EBIT	$(3,600)	$(2,725)	$1,875	$5,000

What is this project's net present value?

Answer 1

Time line		0	1	2	3	4
Cost of new machine		-12000
=Initial Investment outlay		-12000
EBIT			-3600	-2725	1875	5000
-taxes	=(Pretax cash flows)*(1-tax)		-2628	-1989.25	1368.75	3650
+Depreciation			3000	3000	3000	3000
=after tax operating cash flow			372	1010.75	4368.75	6650
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)					2628
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						2628
Total Cash flow for the period		-12000	372	1010.75	4368.75	9278
Discount factor=	(1+discount rate)^corresponding period	1	1.085	1.177225	1.2772891	1.3858587
Discounted CF=	Cashflow/discount factor	-12000	342.8571	858.5869	3420.3298	6694.7662
NPV=	Sum of discounted CF=	-683.46