Question

3: Margarite's Enterprises is considering a new project. The project will require $325,000 for new fixed assets, $160,000 for additional inventory and $35,000 for additional accounts receivable. Short-term debt is expected to increase by $100,000 and long-term debt is expected to increase by $300,000. The project has a 5-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 25% of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $554,000 and costs of $430,000. The tax rate is 35% and the required rate of return is 15%. what is the initial cost of the project? What is the amount of the earnings before interest and taxes for the first year of this project? What is the amount of the after-tax cash flow from the sale of the fixed assets at the end of this project? What is the cash flow recovery from net working capital at the end of this project?

Answer 1

Initial cost or inital outlay = fixed capital investment + working capital investment =325000+(160000+35000-100000)=$420000

Earnings before interest and tax(EBIT) for the first year= sales-operating profit= 554000-430000=$124000

NOTE : After tax cashflows(CFAT)of first year= EBIT(1-t) + D×t

Where

t= tax rate= 35%

D= depreciation (on SLM basis)= (cost-salvage value)/life of project

D= (325000-0)/5 =65000

CFAT= 124000x.65+ 65000×.35=$103350

Part c

After tax cash flow from sale of equipment = sale proceeds -capital gain tax (CGT)

Sale proceeds = 325000×25%=81250

Capital gain tax= ( Sale value- book value)×t= (81250-0)×35%

=28438$

After tax cashflow = 81250-28438=$52812

Part d

Working capital recovery = 160000+35000-100000=95000$