Question

Outdoor Sports is considering adding a putt putt golf course to its facility. The course would cost $179,000, would be depreciated on a straight-line basis over its 6-year life, and would have a zero salvage value. The sales would be $90,000 a year, with variable costs of $28,000 and fixed costs of $12,600. In addition, the firm anticipates an additional $20,100 in revenue from its existing facilities if the putt putt course is added. The project will require $3,200 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 14 percent and a tax rate of 40 percent?

• $19,077

• $51,022

• $29,562

• $27,820

• $31,020

Answer 1

Time line		0	1	2	3	4	5	6
Cost of new machine		-179000
Initial working capital		-3200
=Initial Investment outlay		-182200
Sales			110100	110100	110100	110100	110100	110100
Profits	Sales-variable cost		82100	82100	82100	82100	82100	82100
Fixed cost			-12600	-12600	-12600	-12600	-12600	-12600
-Depreciation	Cost of equipment/no. of years		-29833.3	-29833.3	-29833.33	-29833.33	-29833.33	-29833.33
=Pretax cash flows			39666.67	39666.67	39666.667	39666.667	39666.667	39666.667
-taxes	=(Pretax cash flows)*(1-tax)		23800	23800	23800	23800	23800	23800
+Depreciation			29833.33	29833.33	29833.333	29833.333	29833.333	29833.333
=after tax operating cash flow			53633.33	53633.33	53633.333	53633.333	53633.333	53633.333
reversal of working capital								3200
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								3200
Total Cash flow for the period		-182200	53633.33	53633.33	53633.333	53633.333	53633.333	56833.333
Discount factor=	(1+discount rate)^corresponding period	1	1.14	1.2996	1.481544	1.6889602	1.9254146	2.1949726
Discounted CF=	Cashflow/discount factor	-182200	47046.78	41269.11	36200.972	31755.239	27855.473	25892.502
NPV=	Sum of discounted CF=	27820