White Mountain Consulting is considering a project that would last for 2 years. The project would involve an initial investment of 163,000 dollars for new equipment that would be sold for an expected price of 120,000 dollars at the end of the project in 2 years. The equipment would be depreciated to 19,000 dollars over 6 years using straight-line depreciation. In years 1 and 2, relevant annual revenue for the project is expected to be 163,000 dollars per year and relevant annual costs for the project are expected to be 40,000 dollars per year. The tax rate is 50 percent and the cost of capital for the project is 8.64 percent. What is the net present value of the project?
| Net present value is calculated as present value of cash inflow less present value of cash outflow | ||||||
| Calculation of net present value of project is shown below | ||||||
| Year | 0 | 1 | 2 | |||
| Annual revenue | $163,000 | $163,000 | ||||
| Annual costs | -$40,000 | -$40,000 | ||||
| Depreciation | -$19,000 | -$19,000 | ||||
| Income before taxes | $104,000 | $104,000 | ||||
| Taxes @ 50% | -$52,000 | -$52,000 | ||||
| Net income | $52,000 | $52,000 | ||||
| Depreciation | $19,000 | $19,000 | ||||
| Operating cash flow | $71,000 | $71,000 | ||||
| Initial investment | -$163,000 | |||||
| After tax value of equipment | $122,500 | |||||
| Net cash flow | -$163,000 | $71,000 | $193,500 | |||
| Discount factor @ 8.64% | 1 | 0.92047128 | 0.84726738 | |||
| Present value | -$163,000 | $65,353 | $163,946 | |||
| Net present value | $66,300 | |||||
| Thus, net present value of the project is $66,300. | ||||||
| Calculation of after tax value of equipment | ||||||
| Sale proceeds | $120,000 | |||||
| Book value | $125,000 | 163000-(19000*2) | ||||
| Loss on sale of equipment | $5,000 | |||||
| Tax benefit on loss | $2,500 | 5000*50% | ||||
| After tax sale price | $122,500 | 120000+2500 | ||||
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