Question

Problem 9-11 Calculating Project Cash Flow from Assets [LO 2]

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $1,860,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1,950,000 in annual sales, with costs of $1,060,000. The project requires an initial investment in net working capital of $150,000, and the fixed asset will have a market value of $175,000 at the end of the project. Assume that the tax rate is 35 percent and the required return on the project is 14 percent.

Requirement 1:

What are the net cash flows of the project for the following years? (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answers in dollars, not millions of dollars (e.g., 1,234,567).)

Year	Cash Flow
0	$
1
2
3

Requirement 2:

What is the NPV of the project? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).)

NPV

$

Answer 1

	Year 0	Year 1	Year 2	Year 3
Annual Sales	-	1,950,000	1,950,000	1,950,000
Less: Costs	-	1,060,000	1,060,000	1,060,000
Earnings before depreciation	-	890,000	890,000	890,000
Less: Depreciation	-	620,000	620,000	620,000
Earnings before tax	-	270,000	270,000	270,000
Tax at 35%	-	94,500	94,500	94,500
Earnings after tax	-	175,500	175,500	175,500
Add back depreciation	-	620,000	620,000	620,000
Cash flow from operations	-	795,500	795,500	795,500
Initial Investment	-1860000	-	-	-
Investment in Net working capital	-150000	-	-	150,000
After tax cash flow from sale of asset	0	-	-	113,750
Net Cash flow	-2010000	795,500	795,500	1,059,250
Discount factor at 14%	1	0.877192982	0.769467528	0.674971516
Discounted cash flow	-2010000	697,807.02	612,111.42	714,963.58
NPV =	14,882.01

Formulas used in the table above:

$\textup{Straight line depreciation} = \frac{\textup{Cost of Asset - Salvage value} }{\textup{Useful life}}$

$\textup{After tax cash flow from sale of asset} = \textup{Market price} \times (1-\textup{tax rate})$

$NPV =\textup{ Discounted Cash Inflow - Discounted cash outflow}$

$\textup{Discount factor} = \frac{1}{\left (1+i \right )^n}$
Where,

i = required rate of return
n = number of years.

Other notes:

Depreciation is added back because it is a non-cash expense, but tax deductible.
Investment in Net Working Capital will be released at the end of any project.

Excel formulas:

A B C D Year 0 0 0 0 0 Year 1 1950000 1060000 =C2-C3 =1860000/3 =C4-C5 =C6*35% =C6-C7 =C5 =C8+C9 Year 2 1950000 1060000 =D2-D3 =1860000/3 =D4-D5 =D6*35% =D6-D7 =D5 =D8+D9 E Year 3 1950000 1060000 =E2-E3 =1860000/3 =E4-E5 =E6*35% =E6-E7 =E5 =E8+E9 0 0 0 0 0 1 2 Annual Sales 3 Less: Costs 4 Earnings before depreiciation 5 Less: Depreciation 6 Earnings before tax 7 Tax at 35% 8 Earnings after tax 9 Add back depreciation 10 Cash flow from operations 11 12 Initial Investment 13 Investment in Net working capital 14 After tax cash flow from sale of asset 15 Net Cash flow 16 17 Discount factor at 14% 18 Discounted cash flow 19 20 21 0 0 0 -1860000 - 150000 0 =SUM(B10:B14) 0 0 0 150000 =175000*(1-35%) =SUM(E10:E14) =SUM(C10:C14) =SUM(D10:014) 1 =B17/1.14 =C15*C17 =C17/1.14 =D15*D17 =D17/1.14 =E15*E17 =B15*B17 NPV = =SUM(B18:E18)

If you need any more details or have any doubts, ask me in the comments.