Question

7,Outdoor Sports is considering adding a putt putt golf course to its facility. The course would cost $171,000, would be depreciated on a straight-line basis over its 4-year life, and would have a zero salvage value. The sales would be $93,500 a year, with variable costs of $28,050 and fixed costs of $12,650. In addition, the firm anticipates an additional $20,500 in revenue from its existing facilities if the putt putt course is added. The project will require $3,250 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 13 percent and a tax rate of 34 percent?

Answer 1

Initial Investment for the Project

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

= $171,000 + $3,250

= $174,250

Annual Operating Cash Flow (OCF)

Revenue = $114,000 [$93,500 + $20,500]

Variable Costs = $28,050

Fixed Costs = $12,650

Depreciation Expenses = $42,750 per year [$171,000 / 4 Years]

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

= [($114,000 - $28,050 - $12,650) x (1 – 0.34)] + [$42,750 x 0.34]

= [$73,300 x 0.66] + [$42,750 x 0.34]

= $48,378 + $14,535

= $62,913 per year

Year 1-3 Cash flow = $62,913

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

= $62,913 + $3,250

= $66,163

Net Present Value of the Project

Period	Annual Cash Flow ($)	Present Value factor at 13%	Present Value of Cash Flow ($)
1	62,913	0.884956	55,675.22
2	62,913	0.783147	49,270.11
3	62,913	0.693050	43,601.86
4	66,163	0.613319	40,579.01
TOTAL			1,89,126.20

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

= $1,89,126.20 - $174,250

= $18,126.20

“Therefore, the Net Present Value (NPV) of the Project would be $18,126.20”

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.