Question

Outdoor Sports is considering adding a putt putt golf course to its facility. The course would cost $168,000, would be depreciated on a straight-line basis over its 4-year life, and would have a zero salvage value. The sales would be $90,300 a year, with variable costs of $27,450 and fixed costs of $12,050. In addition, the firm anticipates an additional $15,700 in revenue from its existing facilities if the putt putt course is added. The project will require $2,650 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 11 percent and a tax rate of 34 percent?

• $20,583

• $53,262

• $14,215

• $12,469

• $11,565

Answer 1

Initial Investment for the Project

Initial Investment for the Project = Cost of the asset + Working capital needed

= $168,000 + $2,650

= $170,650

Annual Operating Cash Flow (OCF)

Revenue = $106,000 [$90,300 + $15,700]

Variable Costs = $27,450

Fixed Costs = $12,050

Depreciation Expenses = $42,000 [$168,000 / 4 Years]

Annual Operating Cash Flow (OCF) = [(Sales – Variable Costs – Fixed Costs) x (1 – Tax Rate) + (Depreciation x Tax Rate)

= [($106,000 - $27,450 - $12,050) x (1 – 0.34)] + [$42,000 x 0.34]

= [$66,500 x 0.66] + [$42,000 x 0.34]

= $43,890 + $14,280

= $58,170 per year

Year 1-3 Cash flow = $58,170

Year 4 Cash flow = Annual operating cash flow + Release of working capital

= $58,170 + $2,650

= $60,820

Net Present Value of the Project

Period	Annual Cash Flow ($)	Present Value factor at 11%	Present Value of Cash Flow ($)
1	58,170	0.90090	52,405
2	58,170	0.81162	47,212
3	58,170	0.73119	42,533
4	60,820	0.65873	40,064
TOTAL			182,215

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

= $182,215 - $170,650

= $11,565

“Therefore, the Net Present Value (NPV) of the Project would be $11,565”

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.