Quad Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.29 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $1,810,000 in annual sales, with costs of $720,000. The project requires an initial investment in net working capital of $450,000, and the fixed asset will have a market value of $480,000 at the end of the project.

 

a.If the tax rate is 25 percent, what is the project's Year 0 net cash flow? Year 1? Year 2? Year 3? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, e.g., 1,234,567. A negative answer should be indicated by a minus sign.)

?b.If the required return is 12 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

 

Answer:

a. Cash Flow

Year 0 = -$2,740,000

Year 1 = $1,008,333.33

Year 2 = $1,008,333.33

Year 3 = $1,818,333.33

b. NPV = $258,388.53

Step-by-step explanation

a.The cash flow of year 0, year 1, year 2, and year 3 is calculated as follows:

Year                                                 0                  1                   2                         3

Annual sales                                               $1,810,000     $1,810,000      $1,810,000

Less: costs                                                    $720,000        $720,000          $720,000

Less: depreciation                                    $763,333.33    $766,333.33   $766,333.33

Earnings before tax                                  $326,666.67   $326,666.67    $326,666.67

Less: t..x@25%                                          $81,666.67      $81,666.67       $81,666.67

Earning after tax                                       $245,000          $245,000          $245,000  

Add: Depreciation                                  $763,333.33    $766,333.33   $766,333.33

Operating cash flow                               $1,008,333.33 $1,008,333.33  $1,008,333.33 

Initial investment               -$2,290,000

Working capital                 -$450,000                                                            $450,000

After tax salvage value                                                                                    $360,000

Cash flows                          -$2,740,000  $1,008,333.33  $1,008,333.33   $1,818,333.33

PV F..(@12%)               1                         0.89286         0.797198              0.71178

Present value                     -$2,740,000     $900,297.62    $803,837.16      $1,294,253.75 

Where,

After tax salvage value of plant is calculated as follows:

Salvage value of plant                          $480,000

Book value on date of sale                  $0

Profit on sale                                          $480,000

Salvage value                                         $480,000

Less: tax on gain                                   $120,000

After tax salvage value                        $360,000

b. The NPV of the project is calculated as follows:

NPV = Present value of cash inflow - Present value of cash outflow

        = $2,998,388.53 - $2,740,000

     = $258,388.53