Question

The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new asset and you found the following data:

MACRS class:	3-year (33%, 45%, 15%, 7%)
Economic Life:	3 years
Price:	$300,000
Freight and Installation:	$30,000
Salvage Value:	$60,000
Effect on NWC :	Increase by $10,000
Revenues:	$300,000/year (100,000 units at $3/unit)
Operating Costs excl. depreciation:	50% of sales revenue
Tax rate:	40%
Cost of capital	10%

Use the Project Cash Flow Table below to calculate the relevant after tax cash flows, and then answer the questions concerning investment cost, cash flows, tax on capital gain from sale of the asset, and net present value.

What is the net investment required at t = 0?

What is the non-operating terminal cash flows at the end of Year 3?

How much tax is the firm expected to pay when the asset is sold for $60,000 in year 3?

What is the project's NPV?

What is the operating cash flow in Year 2?

What is the operating cash flow in Year 1?

What is the operating cash flow in Year 3?

Answer 1

The net investment required at t=0
Price of an asset	-$300,000.00
Freight and installation	-$30,000.00
Increase in NWC	-$10,000.00
The net investment required at t=0	-$340,000.00
The non-operating terminal cash flows at the end of Year 3
Recovery of NWC	$10,000.00
Sale of asset	$60,000.00
Tax @ 40% of Gain on sale of an asset [40% of $36,900]	-$14,760.00
The non-operating terminal cash flows at the end of Year 3	$55,240.00
The firm is expected to pay tax when the asset is sold for $60,000 in year 3 = Gain on sale x Tax rate = $36,900 x 40% = $14,760
Calculaton of Operating cash flows
Year	1	2	3
Revenues	$300,000.00	$300,000.00	$300,000.00
Less : Operating Costs excl. depreciation	$150,000.00	$150,000.00	$150,000.00
Less : Depreciation	$108,900.00	$148,500.00	$49,500.00
Profit before tax	$41,100.00	$1,500.00	$100,500.00
Less : Tax @ 40%	$16,440.00	$600.00	$40,200.00
Add : Depreciation	$108,900.00	$148,500.00	$49,500.00
Operating Cash flows	$133,560.00	$149,400.00	$109,800.00
Calculation of NPV of Project
Year	0	1	2	3
Net Investment in project	-$340,000.00
Operating cash flows		$133,560.00	$149,400.00	$109,800.00
Terminal cash flows				$55,240.00
Net Cash Flows	-$340,000.00	$133,560.00	$149,400.00	$165,040.00
x Discount Factor @ 10%	1	0.909090909	0.826446281	0.751314801
Present Value	-$340,000.00	$121,418.18	$123,471.07	$123,996.99
Net Present Value	$28,886.25
Working
Calculation of depreciation on asset and accumulated Depreciation using MACRS
Year	Depreciable value	Depreciation rates	Depreciation	Accumulated Depreciation	Book value of an asset
1	330000	33%	108900	108900	221100
2	330000	45%	148500	257400	72600
3	330000	15%	49500	306900	23100
4	330000	7%	23100	330000	0
Gain on sale of an asset = Sale value - Book value of an asset at the end of 3rd Year = $60000 - $23100 = $36,900