Question

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.

What are the net cash flows of the project for the following years?

What is the NPV of the project?

Answer 1

Answer 2

Hi,

Please find the detailed answer as follows:

Part A:

Net Cash Flows:

Year 0 = - 1860000 - 150000 = -2010000

Annual Cash Inflows = (Sales - Costs - Depreciation)*(1-Tax Rate) + Depreciation = (1950000 - 1060000 - 1860000/3)*(1-.35) + 1860000/3 = 795500

Year 1 Net Cash Inflow = 795500

Year 2 Net Cash Inflow = 795500

Year 3 Net Cash Inflow = 795500 + 150000 (Recovery of Working Capital) + 175000*(1-.35) (Market Value Adjusted for Tax) = 1059250

Part B: NPV

NPV = -2010000 + 795500/(1+.14)^1 + 795500/(1+.14)^2 + 1059250/(1+.14)^3 = 14882.01 or 14882

Thanks.