Question

2. The following I/S is based on the information associated with a new project. Answer the questions. Projected Income Statements Year 4 3 1 2 9,000,000 5,000,000 2,500,000 750,000 750,000 300,000 450,000 Sales 9,000,000 5,000,000 2,500,000 750,000 750,000 300,000 450,000 9,000,000 9,000,000 5,000,000 Variable Cost Fixed Cost 5,000,000 2,500,000 750,000 750,000 300,000 450,000 2,500,000 750,000 750,000 300,000 450,000 Depreciation EBIT Taxes (40%) Net income We plan to invest $3,000,000 to get started. The residual book value of the new equipment is zero at Year 4 and it will be sold for $300,000 at the end of the project. Moreover, we need additional $50,000 in the net working capital (NWC) at the beginning of the project. The tax rate is 40%. Fill out the projected cash flow table. (70 points) Projected Cash Flows Year 4 1 3 OCF ( ( Changes in Nwc ) ( Capital spending Total Cash Flow -3,000,000 II) Figure out both the net present value (NPV) and the profitability index (PI) of this project if the required return is 20%. Based on the NPV and PI, do you accept or reject this project? (50points) III) Figure out the discounted payback period (DPB) for this project if the required return is 20%. If the cutoff is 3 year, do you accept or reject this project? (30points)

Answer 1

Resale Inflows to consider = Salvage Value - Tax Rate (Salvage Value - Book Value)

= 300000 - 0.40 (300000-0) = 180000

Ans 1

	0	1	2	3	4
OCF		1200000	1200000	1200000	1200000
Change in NWC	-50000				50000
Capital Spending	-3000000				180000
Total Cash Flow	-3050000	1200000	1200000	1200000	1430000

Ans 2) NPV is 167399.69

Profitability Index = PV of Future Cash Flow / Initial Investments

= 3217399.69 / 3050000 = 1.05489

	0	1	2	3	4
OCF		1200000	1200000	1200000	1200000
Change in NWC	-50000				50000
Capital Spending	-3000000				180000
Total Cash Flow	-3050000	1200000	1200000	1200000	1430000
Discount Rate @ 20%
PV	-3050000	1000000	833333	694444	689622
NPV	167399.7

Discounted Cash back period is 3.76 years so if cutoff is 3 years we will reject this project.

	0	1	2	3	4
PV of Cash Flow	-3050000	1000000	833333.3333	694444.4444	689621.9136
Cash Flow in Three Years		2527777.778
Remaining	522222.2222
Remaining Cash Flow Divided by Year 4 Cash Flow	0.76