Question

A company is considering a 3-year project that requires an initial installed equipment cost of $10,000. The project engineer has estimated that the operating cash flows will be $5,000 in year 1, $6,000 in year 2, and $9,000 in year 3. The new machine will also require a parts inventory of $1,000 at the beginning of the project (assume this inventory can be sold for cost at the end of the project). It is also estimated that the equipment can be sold as salvage for an after tax salvage cash flow of $5,000 at the end of the project. If the tax rate is 33% and the required rate of return is 12%, what is the net present value (NPV) of this project? (Answer to the nearest dollar.)

Answer 1

Initial Investment for the Project

Initial Investment for the Project = Cost of the Equipment +Working capital required in Inventory

= $10,000 + $1,000

= $11,000

Annual Cash flow for three years

Year 1 Cash Flow = $5,000

Year 2 Cash Flow = $6,000

Year 3 Cash Flow = Annual Cash flow + After-Tax Salvage value + Release of working capital

= $9,000 + $5,000 + $1,000

= $15,000

Net Present Value (NPV) of the Project

Period	Annual Cash Flow ($)	Present Value factor at 12%	Present Value of Cash Flow ($)
1	5,000	0.89286	4,464
2	6,000	0.79719	4,783
3	15,000	0.71178	10,677
TOTAL			19,924

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $19,924 - $11,000

= $8,924

“Therefore, the Net Present Value (NPV) of the Project would be $8,924”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.