Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.4 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 $1,980,000 in annual sales, with costs of $675,000. The project requires an initial investment in net working capital of $200,000, and the fixed asset will have a market value of $310,000 at the end of the project. If the tax rate is 34 percent, what is the project's Year O net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.) Cash Flow Year 0 Year 1 Year 2 Year 3 If the required return is 18 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV

Answer 1

Initial Investment = $2,400,000
Useful Life = 3 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $2,400,000 / 3
Annual Depreciation = $800,000

Initial Investment in NWC = $200,000

Salvage Value = $310,000

After-tax Salvage Value = $310,000 * (1 - 0.34)
After-tax Salvage Value = $204,600

Annual Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = ($1,980,000 - $675,000) * (1 - 0.34) + 0.34 * $800,000
Annual Operating Cash Flow = $1,305,000 * 0.66 + 0.34 * $800,000
Annual Operating Cash Flow = $1,133,300

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$2,400,000 - $200,000
Net Cash Flows = -$2,600,000

Year 1:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,133,300

Year 2:

Net Cash Flows = Operating Cash Flow
Net Cash Flows = $1,133,300

Year 3:

Net Cash Flows = Operating Cash Flow + NWC recovered + After-tax Salvage Value
Net Cash Flows = $1,133,300 + $200,000 + $204,600
Net Cash Flows = $1,537,900

Required return = 18%

NPV = -$2,600,000 + $1,133,300/1.18 + $1,133,300/1.18^2 + $1,537,900/1.18^3
NPV = $110,355.56