Question

Cochrane, Inc., is considering a new three-year fixed expansion project that requires an initial fixed asset investment of $1,860,000. 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 $1,950,000 in annual sales, which costs of $1,060,000. If the tax rate is 35 percent.

In the previous problem, suppose the required return on the project is 14 percent. What is the project's NPV?

NVP

795500[1-(1.14)^-3]/0.14

795500*2.32163203

1846858.28-1,860,000

~$-13141.72

Suppose the project requires an initial investment in net working capital of $150,000, and the fixed asset will have a market value of $175,000 at the end of the project. What is the project's Year 0 net cash flow? Year 1? Year 2? Year 3? What is the new NPV?

Answer 1

Question a:
Particulars	0	1	2	3
Initial Investment
Purchase of Fixed Asset (A)	-1860000
Operating Cash flows
Sales Revenue		1950000	1950000	1950000
Less: Annual Costs		-1060000	-1060000	-1060000
Less: Depreciation (1860000/3 years)		-620000	-620000	-620000
Profit before Tax		270000	270000	270000
Less: Tax @35%		-94500	-94500	-94500
Profit After Tax		175500	175500	175500
Add back Depreciation		620000	620000	620000
Net Operating Cash flows (B)		795500	795500	795500
Total Cash flows (C = A+B)	-1860000	795500	795500	795500
Discount Factor @14% (D) 1/(1+14%)^n n=0,1,2,3	1	0.877193	0.769468	0.674972
Discounted Cash flows (E = C*D)	-1860000	697807	612111.4	536939.8
NPV of the project	-13141.72
Therefore, NPV of the project is -13141.72
Question b:
Particulars	0	1	2	3
Initial Investment
Purchase of Fixed Asset	-1860000
Investment in Working Capital	-150000
Net Investment (A)	-2010000
Operating Cash flows
Sales Revenue		1950000	1950000	1950000
Less: Annual Costs		-1060000	-1060000	-1060000
Less: Depreciation (1860000/3 years)		-620000	-620000	-620000
Profit before Tax		270000	270000	270000
Less: Tax @35%		-94500	-94500	-94500
Profit After Tax		175500	175500	175500
Add back Depreciation		620000	620000	620000
Net Operating Cash flows (B)		795500	795500	795500
Terminal Value
Salvage value pf asset				175000
Less: Tax@35%				-61250
Net salvage value of machine				113750
Working capital recovered				150000
Net Terminal Value (C )				263750
Total Cash flows (D = A+B+C)	-2010000	795500	795500	1059250
Discount Factor @14% (E) 1/(1+14%)^n n=0,1,2,3	1	0.877193	0.769468	0.674972
Discounted Cash flows (F = D*E)	-2010000	697807	612111.4	714963.6
NPV of the project	14882.01
Year 0 Cash flow is -$2010000
Year 1 Cash flow is 697807
Year 2 Cash flow is 612111.4
Year 3 Cash flow is 714963.6
New NPV of the project is 14882.01