Question

5. Tectonic Plating Inc. is considering a new three-year expansion project that re- quires an initial fixed asset investment of $1.65 million. The fixed asset falls into Class 10 for tax purposes (30%), and at the end of the three years can be sold for a salvage value of equal to its UCC. The project is estimated to generate $1,925,000 in annual sale, with costs of $595,000. If the tax rate is 40%, what is the OCF for each year of this project? Suppose the required return is 22%, what is the NPV? Furthermore, suppose the project requires an initial investment in net working capital of $245,000 and the fixed asset will have a market value of $450,000 at the end of the project. What is the new NPV?

Answer 1

		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=Required Return=22%	0.22
		N=Year of Cash Flow
	N	YEAR	0	1	2	3
	A	Annual sale		$1,925,000	$1,925,000	$1,925,000
	B	Costs		$595,000	$595,000	$595,000
	C	Depreciation(30%)		$495,000	$346,500	$242,550
	D	Accumulated depreciation		$495,000	$841,500	$1,084,050
	E=$1.65 m-B	Undepreciated Capital Cost (UCC)		$1,155,000	$808,500	$565,950
	F=A-B-C	Profit Before tax		$835,000	$983,500	$1,087,450
	G=F*0.4	Tax		$334,000	$393,400	$434,980
	H=F-G	Profit after tax		$501,000	$590,100	$652,470
	I=H+C	Operating Cash Flow (OCF)		$996,000	$936,600	$895,020	SUM
	K	Present Value of Operating Cash Flow		$816,393	$629,266	$492,894	$1,938,553
		Present Value of Total Operating Cash flow	$1,938,553
		Initial cash flow	-$1,650,000
		Present Value of Salvage	$311,673	(565950/(1.22^3)
		Net Present Value (NPV)	$600,226
		CALCULATION OF NEW NPV
		Cash Flow for net working capital	($245,000)			$245,000
		Salvage Value				$450,000
		Loss on salvage				$115,950	(565950-450000)
		Saving in Tax(40%)				$46,380
		Net Cash inflow on Salvage				$496,380
		Total additionalCash Flow in year3				$741,380	(245000+496380)
		Present value of additional cash Inflow				$408,283	(741380/(1.22^3)
		Present Value of Total Operating Cash flow	$1,938,553
		Initial cash flow	-$1,650,000
		Additional working Capital investment	($245,000)
		Present value of additional cash Inflow	$408,283
		Net Present Value (NPV)	$451,837