Question

Project cash flow and NPV.The managers of Classic Autos Incorporated plan to manufacture classic Thunderbirds​ (1957 replicas). The necessary foundry equipment will cost a total of ​$4,200,000 and will be depreciated using a​ five-year MACRS​ life,LOADING.... Projected sales in annual units for the next five years are 290 per year. If the sales price is $25,000 per​ car, variable costs are ​$16,000 per​ car, and fixed costs are ​$1,200,000 ​annually, what is the annual operating cash flow if the tax rate is 38​%? The equipment is sold for salvage for ​$525,000 at the end of year five. What is the​ after-tax cash flow of the​ salvage? Net working capital increases by ​$575,000 at the beginning of the project​ (year 0) and is reduced back to its original level in the final year. What is the incremental cash flow of the​ project? Using a discount rate of 12% for the​ project, determine whether the project should be accepted or rejected according to the NPV decision model.

​First, what is the annual operating cash flow of the project for year​ 1?

MACRS Fixed Annual Expense Percentages by Recovery Class         

Year	​3-Year	​5-Year	​7-Year	​10-Year
1	​33.33%	​20.00%	​14.29%	​10.00%
2	​44.45%	​32.00%	​24.49%	​18.00%
3	​14.81%	​19.20%	​17.49%	​14.40%
4	​ 7.41%	​11.52%	​12.49%	​11.52%
5		​11.52%	​8.93%	​9.22%
6		​ 5.76%	​8.93%	​7.37%
7			​8.93%	​6.55%
8			​4.45%	​6.55%
9				​6.55%
10				​6.55%
11				​3.28%

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-4200000
Initial working capital		-575000
=Initial Investment outlay		-4775000
5 years MACR rate			20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
Unit sales			290	290	290	290	290
Profits	=no. of units sold * (sales price - variable cost)		2610000	2610000	2610000	2610000	2610000
Fixed cost			-1E+06	-1200000	-1200000	-1200000	-1200000
-Depreciation	=Cost of machine*MACR%		-840000	-1344000	-806400	-483840	-483840	241920	=Salvage Value
=Pretax cash flows			570000	66000	603600	926160	926160
-taxes	=(Pretax cash flows)*(1-tax)		353400	40920	374232	574219.2	574219.2
+Depreciation			840000	1344000	806400	483840	483840
=after tax operating cash flow			1193400	1384920	1180632	1058059.2	1058059.2
reversal of working capital							575000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						325500
+Tax shield on salvage book value	=Salvage value * tax rate						91929.6	=417429.6=after tax salvage value
=Terminal year after tax cash flows							992429.6
Total Cash flow for the period (incremental)		-4775000	1193400	1384920	1180632	1058059.2	2050488.8
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928	1.5735194	1.7623417
Discounted CF=	Cashflow/discount factor	-4775000	1065536	1104050	840350.54	672415.75	1163502.4
NPV=	Sum of discounted CF=	70854.15881