Question

1. Sway's Back Store is considering a project which will require the purchase of $5 million in new equipment. The equipment will be depreciated straight-line to a book value of $0.5 million over the 5-year life of the project. Annual sales from this project are estimated at $950,000. The variable cost is 40% of the annual sales and there is an annual fixed cost of $100,000. Sway's Back Store will sell the equipment at the end of the project for a salvage value of $0.7 mil. Additional net working capital equal to $0.4 mil to support the project. All of the new net working capital will be recouped at the end of the project. The firm desires a minimal 10% rate of return on this project. The tax rate is 40%. You can use the following tables to construct the cash flows necessary for the NPV calculation. (15 points)

1. What is the annual depreciation?

***Straight-line depreciation expense = (Beginning Value – Ending Value) / life expectancy

2. What is the TAX on salvage?

***Taxes on Salvage = Tax rate * Capital Gain

3. What is the operating cash flow?

***Operating Cash Flow = (Sales-Costs-Depreciation) – Taxes + Depreciation

          or = Net Income + Depreciation

4. What is the project’s NPV?

Answer 1

The annual depreciation (5000000-500000)/5 900,000.00 Tax on salvage value is applicable on the gain over the book value Tax (700000-500000) *0.4 80,000.00 after tax salvage value 700000 - 80000 620,000.00

Operating cash flow Year 2 Year 3 Year 4 Year 5 Capital expenditure Net working capital Year 0 Year 1 (5,000,000.00) (400,000.00) Sales Variable cost Fixed cost Depreciation 950,000.00 380,000.00 100,000.00 900,000.00 950,000.00 380,000.00 100,000.00 900,000.00 950,000.00 380,000.00 100,000.00 900,000.00 950,000.00 380,000.00 100,000.00 900,000.00 950,000.00 380,000.00 100,000.00 900,000.00 (430,000.00) (430,000.00) (430,000.00) (430,000.00) (430,000.00) profit before tax Tax @ 40% Assuming no carry forward of tax on losse (430,000.00) 900,000.00 (430,000.00) (430,000.00) (430,000.00) 900,000.00 900,000.00 900,000.00 Add add Add profit after tax depreciation after tax salvage value working capital (430,000.00) 900,000.00 620,000.00 400,000.00 Free cash flow (5,400,000.00) 470,000.00 470,000.00 470,000.00 470,000.00 1,490,000.00 NPV (2,984,990.47)