Dunay Corporation is considering investing $510,000 in a project. The life of th

Question

Dunay Corporation is considering investing $510,000 in a project. The life of the project would be 6 years. The project would require additional working capital of $42,000 at the beginning. The annual net income from the project (after subtracting depreciation of $36,000 per year) would be $126,000. At the end of the third year, additional working capital of $30,000 will be needed in the project. At the end of the project, the plant assets used in the project will be disposed of for $80,000. Also, working capital of $24,000 will be released for use elsewhere at the end of the project. The company uses a discount rate of 12%. Required: Should the company undertake this project based on its net present value?

Explanation / Answer

Initial investment = 510000 + 42000 = $ 552000

Annual cash flow =Net income +depreciation

                                  = 126000 + 36000 = 162000

Present value of cash flow = [PVAF@12%,6 *annual cash flow ) -(PVF@12%, 3 *Additional working capital required ) + (PVF@12%,6 *{Salvage value +working capital} )

        = (4.11141 * 162000) - (.71178 * 30000 ) +[.50663 * (80000+24000) ]

       = 666048.42 -   21353.4 + 52689.52

        = 697,384.54

NPV =present value -Initial investment

      = 697384.54 - 552000

     = $ 145,384.54

since NPV is positive ,project should be accepted .

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