Question

AF325 Project Cash Flows and NPV Computation Practice - Capital Budgeting - Change in Tax Laws company is looking at a new production system with an installed cost of $560,000. This cost me suaight-line to zero over the project's five-year life, at the end of which the system can be scrapped for 100.000 system will save the firm $165,000 per year in pretax operating costs, and the system requires and in net working capital of $29,000. The tax rate is 34 percent and the discount rate is 10 percent SHOW WORK a. What is the ATSV? b. What are the OCF? c. What is the NPV?

Answer 1

ATSV = After Tax Salvage value = Cash Proceeds - Tax on Gain or Loss on Sale

Tax on Gain on Sale = (Cash proceeds - Book Value)* Tax rate = (85000-0)*34% = $ 28,900

ATSV = 85000 - 28900 = $ 56,100

OCF = Operating Cash Flows:

Pre Tax net Cash flows = 165,000

Less: Depreciation = 560,000/5 = 112,000

EBT = 165000 - 112000 = $ 53,000

EAT = 53000 (1-0.34) = 34,980

OCF = 34,980 + 112,000 = $ 146,980

NPV :

PV of Cash inflow - PV of Cash Outflow

PV of Cash Inflow:

Yrs 1 -4 = $ 146,980 to be discounted @ 10% for 4 years

PV Annuity factor @ 10% for 4 years = 3.1699

Pv of Cash inflow for years 1 to 4 = 146,980 * 3.1699 = 4,65,907

Cash Flow for Year 5 = OCF + ATSV = 146,980 + 56,100 = 203,080

PV of CF of year 5 discounted @ 10% = 203,080 * 1 / 1.1 ^ 5 = 126,097

Total PV cash inflow = 465,907 + 126,097 = 592,004

PV of Cash outflow =   560,000 + 29,000 = 589,000

NPV = 592,004 - 589,000 = $ 3,004