Question

Outdoor Sports is considering adding a putt putt golf course to its facility. The course would cost $172,000, would be depreciated on a straight-line basis over its 5-year life, and would have a zero salvage value. The sales would be $86,500 a year, with variable costs of $27,650 and fixed costs of $12,250. In addition, the firm anticipates an additional $17,300 in revenue from its existing facilities if the putt putt course is added. The project will require $2,850 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 35 percent?

Answer 1

Initial Investment Cost

Initial Investment Cost = Investment in Fixed Assets + Working Capital Required

= $172,000 + $2,850

= $174,850

Annual Operating Cash Flow

Annual Operating Cash Flow = [(Annual Sales + Additional sales – Variable costs – Fixed costs) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($86,500 + $17,300 - $27,650 - $12,250) x (1 – 0.35)] + [($172,000 / 5 Years) x 0.35]

= [$63,900 x 0.65] + [$34,400 x 0.35]

= $41,535 + $12,040

= $53,575

Year 1 – 4 Annual Operating Cash Flow = $53,575

Year 5 Operating Cash Flow = Annual Operating Cash Flow + Release of Net Working Capital

= $53,575 + $2,850

= $56,425

Net Present Value (NPV) of the Project

Period	Annual Cash Flow ($)	Present Value factor at 13%	Present Value of Cash Flow ($)
1	53,575	0.884956	47,411.50
2	53,575	0.783147	41,957.08
3	53,575	0.693050	37,130.16
4	53,575	0.613319	32,858.55
5	56,425	0.542760	30,625.23
TOTAL			1,89,982.53

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

= $189,982.53 - $174,850

= $15,132.53

“Therefore, the Net Present Value (NPV) of the Project will be $15,132.53”

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.