Question

Lincoln Inc. is considering a new project which requires an initial investment of $6 million today. The investment involves the purchase of a machine with a CCA rate of 30%. Revenues less expenses for this project are expected to be $2 million per year for 4 years. The project requires an immediate $200,000 increase in net working capital and the working capital will grow at 3% each year in the following years. Lincoln Inc. expects to sell the machine at the end of its 4-year operating life for $100,000.

The effective corporate tax rate is 35%. And Lincoln uses a 10% cost of capital to evaluate projects of this nature.Calculate the NPV for this investment.

Should Lincoln implement this project?

Answer 1

All financials below are in $. Please be guided by the second column called "Linkage" to understand the mathematics behind each row. Figures in parenthesis mean negative values.

NPV appears at the end of the table.

Year, N	Linkage	0	1	2	3	4
Initial investment	A	(6,000,000)
Opening block	B		6,000,000	4,200,000	2,940,000	2,058,000
Depreciation	C = 30% x B		(1,800,000)	(1,260,000)	(882,000)	(617,400)
Closing block	D = B + C		4,200,000	2,940,000	2,058,000	1,440,600
Revenue less costs	E		2,000,000	2,000,000	2,000,000	2,000,000
Depreciation	C		(1,800,000)	(1,260,000)	(882,000)	(617,400)
EBIT	F = E + C		200,000	740,000	1,118,000	1,382,600
Taxes	G = -35% x F		(70,000)	(259,000)	(391,300)	(483,910)
NOPAT	H = F + G		130,000	481,000	726,700	898,690
Operating cash flows	I = H -C		1,930,000	1,741,000	1,608,700	1,516,090
Investment in working capital	J	(200,000)	(206,000)	(212,180)	(218,545)	836,725
Salvage value	K					100,000
Gain on sale	L = K - D					(1,340,600)
Tax on gain	M = -35% x L					469,210
Post tax salvage value	N = K + M					569,210
Net cash flows	O = A+I+J+N	(6,200,000)	1,724,000	1,528,820	1,390,155	2,922,025
Discount rate	P	10%
Discount factor	Q = (1+P)^(-N)	1.0000	0.9091	0.8264	0.7513	0.6830
PV of cash flows	R = O x Q	(6,200,000)	1,567,273	1,263,488	1,044,444	1,995,783
NPV	Sum of all R	(329,013)

NPV = - $ 329,013

Since NPV is negative, this investment should not be undertaken.