Question

H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,350,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $3,330,000 in annual sales, with costs of $2,330,000. The project requires an initial investment in net working capital of $180,000 and the fixed asset will have a market value of $215,000 at the end of the project. Assume that the tax rate is 23 percent and the required return on the project is 11 percent. a. What are the net cash flows of the project each year? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) b. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Years	Cash Flow
Year 0	-$2.530,000
Year 1	$950,167
Year 2	$950,167
Year 3	$1,295,717

Calculate of Annual Cash Flow

Particulars	Amount ($)
Annual Sales	33,30,000
Less : Costs	23,30,000
Less: Depreciation [$2,350,000 / 3 Years]	7,83,333
Net Income Before Tax	2,16,667
Less : Tax at 23%	49,833
Net Income After Tax	1,66,833
Add Back : Depreciation	7,83,333
Annual Cash Flow	9,50,167

Year 0 Cash outflow

Year 0 Cash outflow = Initial Investment + Working Capital

= -$2,350,000 - $180,000

= -$2,530,000

Year 1 Cash Flow = $950,167

Year 2 Cash Flow = $950,167

Year 3 Cash Flow

Year 3 Cash Flow = Annual cash flow + Working capital + After-tax market value

= $950,167 + $180,000 + [$215,000 x (1 – 0.23)]

= $950,167 + $180,000 + [$215,000 x 0.77]

= $950,167 + $180,000 + $165,550

= $1,295,717

Net Present Value (NPV) of the Project

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= [$950,167 / (1 + 0.11)¹] + [$950,167 / (1 + 0.11)²] + [$1,295,717 / (1 + 0.11)³] - $2,530,000

= [($950,167 / 1.11) + ($950,167 / 1.2321) + ($1,295,717 / 1.367631)] - $2,530,000

= [$8,56,006.01 + $7,71,176.58 + $9,47,416.86] - $2,530,000

= $2,574,599.45 - $2,530,000

= $44,599.45

“Hence, the Project’s Net Present Value (NPV) will be $44,599.45”