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A project requires to purchase an equipment with a cost of $1.55 million. The equipment will...

A project requires to purchase an equipment with a cost of $1.55 million. The equipment will be depreciated straight-line to a zero book value over the 9-year life of the project. At the end of the project it will be sold for a market value of $240,000. The project will not change sales but will reduce operating costs by $399,000 per year. The project also requires an initial investment of $52,000 in net working capital, which will be recouped when the project ends. The tax rate is 34 percent. (1) What is the cash flow of the project in year 0 (or at the beginning of the project)? (2) What is the cash flow of the project in each year from year1 to year 8? (3) What is the cash flow of the project in year 9 (or the ending year)? [hint: there are 3 cash flow items, for example after-tax salvage value] (4) What is the project's NPV if the required return is 11.5 percent? [hint: the answer for NPV value is one of the following choices:] A. $215,433 B. $276,945 C. $268,011 D. $225,225 E. $257,703

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  Answer

Initial Investment
Cost of machine 1550000
Additional Working Capital Required 52000
Total Initial Cash Flow 1602000
Intermediate Cash Flow
Reduction in Operating Cost 399000
(-)Depreciation (1550000/9) 172222.22
Saving Before Tax 226777.78
(-)Tax@34% 77104.44
Saving After Tax 149673.33
(+)Depreciation 172222.22
CFAT 321895.56
Terminal Cash Flow
Sale of Scrap after tax(240000*(1-.34) 158400
CFAT 321895.56
Recovery of Working Capital 52000
Total Terminal CF 532295.5556

Net present value =Present value of CFAT+Present Value of Terminal Cash Flow-Initial Cash Flow

Present Value of CFAT=CFAT*PV factor of annuity for 8 years @11.5%

=321895.56*5.055636778

=1627387

PV Factor of annuity=[(1+r)^n-1] / [(1+r)^n*r]

=[(1+.115)^8-1] / [(1+.115)^8*.115]

=5.055637

PV of terminal Cash Flow= Terminal Cash Flow/(1+r)^n

=532295.5556/(1.115)^9

=199838.4413

Net present value =1627387+199838.4413-1602000

=225225.44 or 225225

Hence answer is (D)225225

Rahul Sunny answered 1 year ago
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