Question

1. The Smith & Warner Company is considering an expansion of its production facilities which will permit the firm to build and sell a new line of cell phones. The project requires a $10,000,000 capital investment and is expected to have a three-year economic life.
   Other relevant information is :

• At the end of the project, the equipment can be sold for $300,000.
• The firm’s WACC is estimated at 8%.
• Incremental sales are projected to be $12,000,000 per year.
• Annual costs(excluding depreciation) are estimated to be $3,000,000
• The project requires a $2,000,000 initial investment in net operating working capital.
• The expected tax rate is 33%.

The MACRS depreciation schedule in the list below will be used:

• Year 1 = 0.4445
• Year 2 = 0.3333
• Year 3 = 0.1481
• Year 4 = 0.0741

Calculate and show the project cash flows for years 0 through 3.

Answer 1

	0	1	2	3
capital investment	-10,000,000
initial investment in net operating working capital.	-2,000,000
Incremental sales		12,000,000	12,000,000	12,000,000
less: Annual costs(excluding depreciation)		-3,000,000	-3,000,000	-3,000,000
Depreciation		- 4,445,000 [10,000,000*.4445]	-3,333,000	--1,481,000
Income before tax		4555000	5667000	7519000
less;tax		-1503150   [4555000*.33]	-1870110	-2481270
Net income		3051850	3796890	5037730
Add:depreciation		4445000	3333000	1481000
After tax sale value				445530
working capital released				2000000
cash flow	-12,000,000	7496850	7129890	8964260

***Book value at year 3 =10000000*7.41%=741000

Gain/(loss) on sale = 300000-741000=-441000

Tax saving due to loss = 441000*.33 = 145530

After tax sale value =sale value +tax saving

                 = 300000+145530 = 445530