Question

A company is evaluating the acquisition of a new piece of equipment. The base price of the equipment is $100,000 and it will cost an additional $10,000 for shipping and installation. The company also paid a firm $5,000 to determine the feasibility of the new piece of equipment. The equipment falls in the MACRS 3 year class and would be sold after 4 years for $18,000. The new equipment would require an increase in inventory of $4,000, which will be recovered at the end of the project. The equipment is expected to generate an extra $30,000 per year in revenues, but have no effect on operating costs. WACC is 10% and its marginal tax rate is 40%.

MACRS 3 year class: Year 1: 33%; Year 2: 44%; Year 3: 14%; Year 4: 7%

1. What is the Year 0 Cash Flow?

2. What is the Operating Cash Flow in Years 1 and 2?

3. What is the Free Cash Flow in Year 3?

4. What is the NPV?

Answer 1

1)
Equipment	$  100,000.00
Add: shipping and installation	$    10,000.00
Net cost of Equipment	$  110,000.00
Add: Working Capital	$      4,000.00
Cash flow in Year 0	$  114,000.00
2)
	1	2	3	4
Pre tax savings	$    30,000.00	$ 30,000.00	$ 30,000.00	$ 30,000.00
Less: dep.	$   (36,300.00)	$(48,400.00)	$(15,400.00)	$7,700
EBIT	$     (6,300.00)	$(18,400.00)	$ 14,600.00	$ 37,700.00
Less Tax 40%	$      2,520.00	$   7,360.00	$  (5,840.00)	$(15,080.00)
NOPAT	$     (3,780.00)	$(11,040.00)	$   8,760.00	$ 22,620.00
Add: Dep	$    36,300.00	$ 48,400.00	$ 15,400.00	$7,700
OCF	$    32,520.00	$ 37,360.00	$ 24,160.00	$ 30,320.00
Year	Depreciation Rate	Depreciation = $110,000 x Depreciation rate
1	33.00%	$36,300
2	44.00%	$48,400
3	14.00%	$15,400
4	7.00%	$7,700
3)
Free cash flow = OCF - Capital expenditure
Free cash flow = 24,160 - $0	$    24,160.00
4)
After-tax cash flow at disposal  = $18000 x ( 1-40%)	$    10,800.00
Year	0	1	2	3	4
Cost of Equipment	$ (110,000.00)
Add: Working capial	$     (4,000.00)				$   4,000.00
OCF		$ 32,520.00	$ 37,360.00	$ 24,160.00	$ 30,320.00
Salvage Value					$ 10,800.00
Net OCF	$ (114,000.00)	$ 32,520.00	$ 37,360.00	$ 24,160.00	$ 45,120.00
PV @ 10%	$             1.00	$      0.9091	$      0.8264	$      0.7513	$      0.6830
Present Value	$ (114,000.00)	$ 29,563.64	$ 30,876.03	$ 18,151.77	$ 30,817.57
NPV	$     (4,591.00)