Question

Question Il of 24 Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life. Under the new tax law, the equipment is eligible for 100% bonus depreciation, so it will be fully depreciated at t = 0. The equipment would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, additional net operating working capital (NOWC) would be required, but it would be recovered at the end of the project's life. Revenues and operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC 10.0% Equipment cost $70,000 Required net operating working capital (NOWC) $10,000 Annual sales revenues $61,000 Annual operating costs $30,000 Expected pre-tax salvage value $5,000 Tax rate 25.0% a. $5,773 b. $5,011 c. $5,650 d. $5,982 e. $5,668

Answer 1

70000 Given Equipment Cost Life Salvage Value Required bet operating working capital (NOWC) Annual Sales revenues Annual operating cost Income (Sales - operating cost) Tax Rate Cost of capital 5000 10000 61000 30000 31000 25% 10% Solution Step 2: Calculate NPV Year Income CFAT CFC PVE PV Working Capital -10000 10 0 Tax Saving on CESP Depreciation 0 117500 -70000 23250 23250 23250 ol3750 O -62500 23250 23250 37000 31000 31000 31000 2 3 1 -62500 0.909 21136 0.826 19215 0.751 27799 NPV 5650 10000 where, Tax Saving on Depreciation CFAT (Cash flow after Tax) = CFAT CFSP CFC (free cash flow) PVF (Present Value Factor) = where r is discount rate, n is year PV (Present Value) = Depreciation X Tax Rate Income X (1 - Tax Rate) CFADT + Depreciation Cashflow due to sale and purchase of asset CFAT + Tax saving on depreciation + CFSP + Working Capital (1/(1+r)^n CFCX PVF Hence, option c $ 5650 is correct