Question

Large Manufacturing, Inc. is considering investing in some new equipment whose data are shown below. The equipment has a 3-year class life and will be depreciated by the MACRS depreciation system, and it will have a positive pre-tax salvage value at the end of Year 3, when the project will be closed down. Also, some new working capital will be required, but it will be recovered at the end of the project's life. Revenues and cash operating costs are expected to be constant over the project's 3-year life.

WACC 11.0%

Net investment in fixed assets (depreciable basis) $70,000

Required new working capital $10,000

Sales revenues, each year $95,000

Cash operating costs excl. depr'n, each year $30,000

Expected pretax salvage value $9,000

Tax rate 30.0%

What is the terminal Year Non–Operating Cash Flow at the end of Year 3?  

What is the project’s NPV?

Answer 1

Time line		0	1	2	3
Cost of new machine		-70000
Initial working capital		-10000
=Initial Investment outlay		-80000
3 years MACR rate			33.33%	44.45%	14.81%	7.41%
Sales			95000	95000	95000
Profits	Sales-variable cost		95000	95000	95000
Operating cost			-30000	-30000	-30000
-Depreciation	=Cost of machine*MACR%		-23331	-31115	-10367	5187	=Salvage Value
=Pretax cash flows			41669	33885	54633
-taxes	=(Pretax cash flows)*(1-tax)		29168.3	23719.5	38243.1
+Depreciation			23331	31115	10367
=after tax operating cash flow			52499.3	54834.5	48610.1
reversal of working capital					10000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				6300
+Tax shield on salvage book value	=Salvage value * tax rate				1556.1
=Terminal year after tax cash flows					17856.1
Total Cash flow for the period		-80000	52499.3	54834.5	66466.2
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631
Discounted CF=	Cashflow/discount factor	-80000	47296.66667	44504.91	48599.513
NPV=	Sum of discounted CF=	60401.08957