Question

H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,430,000. The fixed asset will be depreciated straight- line to zero over its three-year tax life. The project is estimated to generate $2,810,000 in annual sales, with costs of $1,790,000. The project requires an initial investment in net working capital of $166,000 and the fixed asset will have a market value of $201,000 at the end of the project. Assume that the tax rate is 24 percent and the required return on the project is 10 percent. a. What are the net cash flows of the project each year? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) b. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) a. Year 0 cash flow Year 1 cash flow Year 2 cash flow Year 3 cash flow b. NPV

Answer 1

Time line		0	1	2	3
Cost of new machine		-2430000
Initial working capital		-166000
=Initial Investment outlay		-2596000
						100.00%
Sales			2810000	2810000	2810000
Profits	Sales-variable cost		1020000	1020000	1020000
-Depreciation	Cost of equipment/no. of years		-810000	-810000	-810000	0	=Salvage Value
=Pretax cash flows			210000	210000	210000
-taxes	=(Pretax cash flows)*(1-tax)		159600	159600	159600
+Depreciation			810000	810000	810000
=after tax operating cash flow			969600	969600	969600
reversal of working capital					166000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				152760
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					318760
a. Total Cash flow for the period		-2596000	969600	969600	1288360
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-2596000	881454.5455	801322.314	967963.9369
b. NPV=	Sum of discounted CF=	54740.80