Skolfield Corporation is considering a capital budgeting project that would requ

Question

Skolfield Corporation is considering a capital budgeting project that would require investing $280,000 in equipment with an expected life of 4 years and zero salvage value. Annual incremental sales would be $590,000 and annual incremental cash operating expenses would be $470,000. The project would also require an immediate investment in working capital of $20,000 which would be released for use elsewhere at the end of the project. The project would also require a one-time renovation cost of $30,000 in year 3. The company's income tax rate is 30% and its after-tax discount rate is 15%. The company uses straight-line depreciation. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.The net present value of the entire project is closest to: A $94,128 B $214,128 C $168,000 D $147,660

Explanation / Answer

Annual Depreciation = (cost-salvage value)/useful life

Annual Depreciation = (280000-0)/4

Annual Depreciation = 70000

Annual Cash flow = (Sale- cash operating expenses )*(1-tax rate) + Annual Depreciation* tax rate

Annual Cash flow = (590000-470000)*(1-30%) + 70000*30%

Annual Cash flow = 105000

Renovation cost in year 3 after tax = 30000*(1-30%) = 21000

Initial Investment = Equipment Cost + Working capital

Initial Investment = 280000+20000

Initial Investment = 300000

Terminal Value = Salvage value + Working capital

Terminal Value = 0 + 20000

Terminal Value = 20000

Net present value = -Initial Investment + Annual Cash flow *PVA(15%,4) - Renovation cost in year 3 after tax *PV(15%,3) + Terminal Value*PV(15%,4)

Net present value = -300000 + 105000*2.855 - 21000*0.658 + 20000*0.572

Net present value = -2603

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