Question

Garden-Grow Products is considering a new investment whose data are shown below. The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require some additional working capital that would be recovered at the end of the projects to Revenues and other operating costs are expected to be constant over the project's life. What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 3) WACC Net investment in fixed assets (basis) 10.0% $75,000 Required new working capital $15,000 Straight-line deprecate 33.333% Sales revenues, each year $75,000 Operating costs (excl. deprec.), each year $25,000 Tax rate 35.0% $23,852 $25,045 $26,297 $27,612 $28.993

Answer 1

NPV: $23,852

CASH FLOWS FOR YEARS 1 THROUGH 3 Sales $ Less: costs $ Less: depreciation $ Profit before tax $ Less: taxes (25000*35%) $ Profit after tax $ Add back: depreciation $ Cashflow after tax $ 75,000 (25,000) (25,000) 25,000 (8,750) 16,250 25,000 41,250

• Depreciation per annum = $75,000 × 33.333% = $25,000 (rounded off).
• Depreciation is a non-cash item. Therefore it is added back to arrive at net cash inflow.

a Year(s) Cash flow 10% Factor PV of cash flows b ахь Investment in equipment Now $ (75,000) 1.00000 $ (75,000.00) Working capital investment Now $ (15,000) 1.00000 $ (15,000.00) Yearly cash inflow 1 through 3 $ 41,250 2.48685 $ 102,582.56 Salvage value of equipment $ 0.75131 $ Release of working capital 3 $ 15,000 0.75131 $ 11,269.65 Net present value $ 23,852.21 3

1-(1 + i)-n Present Value Annuity Factor PVAF i = required rate per period = 10% n=number of periods = 3 years PVAF 1-(1+0.10)-3 2.48685 0.10 PV factor 1 (1 + i) i = required rate per period = 10% n = 3 PVF = 0.75131 (1+0.10) 1

• Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over the life of an investment project.
• NPV is used to evaluate investment projects in capital budgeting.
• A project with a positive NPV is accepted. A positive NPV indicates that the project will result in net cash inflows in today's dollars.
• A project with a negative NPV is rejected. A negative NPV indicates that the project will result in net cash outflows in today's dollars.
• The cash flows are discounted at a required rate of return. It may be a weighted average cost of capital, cost of debt, etc.