Question

You are considering an investment project. The project has a life of three years. Project Information: Initial investment into a new machine, which would cost Rs.4,50,000. Machine is to be depreciated to zero over three years (straight line depreciation) with no salvage value at the end. Operating revenue is expected to be Rs. 6,00,000 per year. Operating costs for raw materials expected to be Rs.3,00,000 per year. Assume tax rate is 30% and the discount rate is 20%.

a. Compute after-tax cash flows every year. 300 Words

b. Evaluate the project NPV. Would you accept the project? 300 Words

Answer 1

(a)-After-Tax Cash Flow

After-Tax Cash Flow = [(Annual Revenue - Costs) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($600,000 - $300,000) x (1 – 0.30)] + [($450,000 / 3 Years) x 0.30]

= [$300,000 x 0.70] + [$150,000 x 0.30]

= $210,000 + $45,000

= $255,000 per year

“After-Tax Cash Flow will be $255,000 per year”

(b)-Net Present Value (NPV) of the Project

Period	Annual Cash Flow ($)	Present Value factor at 20%	Present Value of Cash Flow ($)
1	2,55,000	0.8333333	2,12,500.00
2	2,55,000	0.6944444	1,77,083.33
3	2,55,000	0.5787037	1,47,569.44
TOTAL			5,37,152.78

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

= $537,152.78 - $450,000

= $87,152.78

“Net Present Value (NPV) of the Project will be $87,152.78”

DECISION

YES. The Project should be accepted, since it has the Positive Net Present Value of $87,152.78

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.