Question

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Project cash flow and NPV. The managers of Classic Autos Incorporated plan to manufacture classic Thunderbirds (1957 replicas). The necessary foundry equipment will cost a total of $4,000,000 and will be depreciated using a five-year MACRS life, The sales manager has an estimate for the sale of the classic Thunderbirds. The annual sales volume will be as follows: Year one: 250 Year two: 280 Year three: 360 Year four: 360 Year five: 320 If the sales price is $26,000 per car, variable costs are $20,000 per car, and fixed costs are $1,100,000 annually, what is the annual operating cash flow if the tax rate is 30%? The equipment is sold for salvage for $500,000 at the end of year five. Net working capital increases by $600,000 at the beginning of the project (year 0) and is reduced back to its original level in the final year. Find the internal rate of return for the project using the incremental cash flows. First, what is the annual operating cash flow of the project for year 1? (Round to the nearest dollar.) What is the annual operating cash flow of the project for year 2?

Answer 1

Operating cash flow (OCF) each year = income after tax + depreciation

In year 5, the entire working capital investment is recovered.

profit on sale of equipment at end of year 5 = salvage value - book value

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value - tax on profit on sale of equipment   

NPV is calculated using IRR function in Excel

IRR is 1.79%

A B C D E F 1 0 1 2 2 3 4 $4,000,000 $600,000 2 Initial Investment 3 Cost of equipment 4 Increase in working capital 5 6 OCE 7 Units sold 8 Revenues 9 - Variable Costs 10 - Fixed Costs 11 - Depreciation 12 Earnings before tax 13 - Taxes 14 Earnings after tax 15 + Depreciation 16 OCF $6,500,000 $7,280,000 $5,000,000 $5,600,000 $1,100,000 $1,100,000 $800,000 $1,280,000 ($400,000) ($700,000) ($120,000) ($210,000) ($280,000) ($490,000) $800,000 $1,280,000 $520,000 $790,000 360 360 320 $9,360,000 $9,360,000 $8,320,000 $7,200,000 $7,200,000 $6,400,000 $1,100,000 $1,100,000 $1,100,000 $768,000 $460,800 $460,800 $292,000 $599,200 $359,200 $87,600 $179,760 $107,760 $204,400 $419,440 $251,440 $768,000 $460,800 $460,800 $972,400 $880,240 $712,240 17 18 Terminal Cash Flow 19 Salvage Value 20 Accumulated depreciation 21 Book value of equipment 22 Profit on sale of equipment 23 Tax 24 Salvage Value after tax 25 Return of working capital 26 Terminal Cash Flow 27 28 NPV Analysis 29 Incremental Cash Flows $500,000 $3,769,600 $230,400 $269,600 $80,880 $419,120 $600,000 $1,019,120 ($4,600,000) $520,000 $790,000 $972,400 $880,240 $1,731,360 30 31 IRR 1.79%

А B DE 2 Initial Investment 3 Cost of equipment 4. Increase in working capital 4000000 600000 250 280 360 360 320 =C7*26000 =D7-26000 =E7*26000 =F7*26000 =G7*26000 =C720000 =D720000 =E720000 =F7.20000 =G7*20000 1100000 1100000 1100000 1100000 1100000 =$B$3*20% =$B$3*32% =$B$3.19.2% =$B$311.52% =$B$311.52% =C8-C10-C9-C11 =D8-D10-D9-D11 =E8-E10-E9-E11 =F8-F10-F9-F11 =G8-G10-G9-G11 =C12-30% =D12*30% =E12*30% =F12*30% =G12*30% =C12-C13 =D12-D13 =E12-E13 =F12-F13 =G12-G13 =C11 =D11 =E11 =F11 =G11 =C14+C15 =D14+D15 =E14+E15 =F14+F15 =G14 G15 6 OCF 7 Units sold 8 Revenues 9 - Variable Costs 10 - Fixed Costs 11 - Depreciation 12 Earnings before tax 13 - Taxes 14 Earnings after tax 15 + Depreciation 16 OCF 17 18 Terminal Cash Flow 19 Salvage Value 20 Accumulated depreciation 21 Book value of equipment 22 Profit on sale of equipment 23 Tax 24 Salvage Value after ta 25 Return of working capital 26 Terminal Cash Flow 27 28 NPV Analysis 29 Incremental Cash Flows 30 31 IRR 500000 =SUM(C11:611) =B3-G20 =G19-G21 =G22*30% =G19-G23 =B4 =G24+G25 =-B3-B4 =C16 =D16 =E16 =F16 =G16+G26 =IRR(B29:G29)