Question

The initial investment in Plant and Equipment will be $175,000.

The equipment will be depreciated on a straight-line basis over 5 years with no expected salvage value. The project will also require an initial investment in net working capital of $30,000 which the company will recover at the end of the 5 year period. Sales are forecast to be $220,000 each year, with cash operating expenses of $90,000. The company tax rate is 30%, and their weighted average cost of capital is 10%

Evaluate the project described above and advise the company as to whether or not they should undertake the investment. Show all working.

Answer 1

Computation of NPV of Investment Particulars Years 0 1 2 3 3 4 5 5 Cash Outflows: Initial Investment Working Capital Cash operaring expenses (1,75,000) (30,000) (90,000) (90,000) (90,000) (90,000) (90,000) 2,20,000 2,20,000 2,20,000 2,20,000 Cash Inflows Annual Sales Working Capital Recovered Tax savings on Depreciation 2,20,000 30,000 10,500 10,500 10,500 10,500 10,500 Net Cash flows A = PV factor @ 10% B= Present Value (AxB) = (2,05,000) 1.000 (2,05,000) 1,40,500 0.90909 1,27,727 1,40,500 0.82645 1,16,116 1,40,500 0.75131 1,05,560 1,40,500 0.68301 95,963 1,70,500 0.62092 1,05,867 Net Present Value : 3,46,233 As the Net Present Value (NPV) is positive, the Investment should be made

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