Question

Howell Petroleum is considering a new project that complements its existing business. The machine required for the project costs $3.96 million. The marketing department predicts that sales related to the project will be $2.66 million per year for the next four years, after which the market will cease to exist. The machine will be depreciated down to zero over its four-year economic life using the straight-line method Cost of goods sold and operating expenses related to the project are predicted to be 25 percent of sales. Howell also needs to add net working capital of $310,000 immediately. The additional net working capital will be recovered in full at the end of the project's life. The corporate tax rate is 34 percent. The required rate of return for the project is 16 percent. What is the value of the NPV for this project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g. 32.16.) $ NPV Should the company proceed with the project? No Yes

Answer 1

Time line		0	1	2	3	4
Cost of new machine		-3960000
Initial working capital		-310000
=Initial Investment outlay		-4270000
							100.00%
Sales			2660000	2660000	2660000	2660000
Profits	Sales-variable cost		1995000	1995000	1995000	1995000
-Depreciation	Cost of equipment/no. of years		-990000	-990000	-990000	-990000	0	=Salvage Value
=Pretax cash flows			1005000	1005000	1005000	1005000
-taxes	=(Pretax cash flows)*(1-tax)		663300	663300	663300	663300
+Depreciation			990000	990000	990000	990000
=after tax operating cash flow			1653300	1653300	1653300	1653300
reversal of working capital						310000
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						310000
Total Cash flow for the period		-4270000	1653300	1653300	1653300	1963300
Discount factor=	(1+discount rate)^corresponding period	1	1.16	1.3456	1.560896	1.8106394
Discounted CF=	Cashflow/discount factor	-4270000	1425258.621	1228671.225	1059199.332	1084313.1
NPV=	Sum of discounted CF=	527442.29

Accept project as NPV is positive