Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $3 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,180,000 in annual sales, with costs of $875,000. The tax rate is 30 percent and the required return is 9 percent. What is the project’s NPV?

Answer 1

Using the tax shield approach to calculating OCF, we get:

OCF = (Sales − Costs)(1 − t_C) + t_C(Depreciation)

OCF = ($2,180,000 − 875,000)(1 − 0.3) + 0.3($3,000,000 / 3)

OCF = $1,213,500

So, the NPV of the project is:

NPV = −$3,000,000 + $1,213,500(PVIFA_9%,3)

NPV = $71,726.08