LM Company is considering investing in a new project that will generate cash inf
ID: 2525124 • Letter: L
Question
LM Company is considering investing in a new project that will generate cash inflows of $45,000 every year for the ten-year life of the project. Investing in this new project will require the purchase of a new machine, which will co st $200,000. The machine will have a salvage value of $15,000 at the end of ten years, but will require a repair costing $6,000 at the end of year four and a repair costing $10,000 at the end of year seven. In addition, this project wi 1l require an immediate investment of $40,000 in working capital which would be released for investment elsewhere at the end of the ten years. LM Company has a cost of capital of 8% and an income tax rate of 40% Calculate the net present value CNPV) of the new project.Explanation / Answer
Solution:
Year
0
1
2
3
4
5
6
7
8
9
10
Initial Investment
($200,000)
Working Capital Requirement
($40,000)
Annual Cash Inflow
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
Less: Repair Cost
($6,000)
($10,000)
Add: Salvage Value
$15,000
Less: Annual Depreciation (Refer Note 1 )
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
Net Income before Tax
$26,500
$26,500
$26,500
$20,500
$26,500
$26,500
$16,500
$26,500
$26,500
$41,500
Less: Tax @ 40%
($10,600)
($10,600)
($10,600)
($8,200)
($10,600)
($10,600)
($6,600)
($10,600)
($10,600)
($16,600)
Net Income after tax
$15,900
$15,900
$15,900
$12,300
$15,900
$15,900
$9,900
$15,900
$15,900
$24,900
Plus: Depreciation Expense
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
Net Cash Flows
($240,000)
$34,400
$34,400
$34,400
$30,800
$34,400
$34,400
$28,400
$34,400
$34,400
$43,400
Plus: Release of Working Capital
$40,000
Total Net Cash Flows
($240,000)
$34,400
$34,400
$34,400
$30,800
$34,400
$34,400
$28,400
$34,400
$34,400
$83,400
PV factor @ 8%
1
0.9259
0.8573
0.7938
0.735
0.6806
0.6312
0.5835
0.5403
0.5003
0.463
Present Value
($240,000)
$31,850.96
$29,491.12
$27,306.72
$22,638.00
$23,412.64
$21,713.28
$16,571.40
$18,586.32
$17,210.32
$38,614.20
Net Present Value
$7,395
Note 1 – Annual Depreciation
Annual Depreciation = (Cost of machine 200,000 – Salvage Value 15,000) / Estimated Useful Life 10
= $18,500
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Year
0
1
2
3
4
5
6
7
8
9
10
Initial Investment
($200,000)
Working Capital Requirement
($40,000)
Annual Cash Inflow
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
Less: Repair Cost
($6,000)
($10,000)
Add: Salvage Value
$15,000
Less: Annual Depreciation (Refer Note 1 )
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
($18,500)
Net Income before Tax
$26,500
$26,500
$26,500
$20,500
$26,500
$26,500
$16,500
$26,500
$26,500
$41,500
Less: Tax @ 40%
($10,600)
($10,600)
($10,600)
($8,200)
($10,600)
($10,600)
($6,600)
($10,600)
($10,600)
($16,600)
Net Income after tax
$15,900
$15,900
$15,900
$12,300
$15,900
$15,900
$9,900
$15,900
$15,900
$24,900
Plus: Depreciation Expense
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
$18,500
Net Cash Flows
($240,000)
$34,400
$34,400
$34,400
$30,800
$34,400
$34,400
$28,400
$34,400
$34,400
$43,400
Plus: Release of Working Capital
$40,000
Total Net Cash Flows
($240,000)
$34,400
$34,400
$34,400
$30,800
$34,400
$34,400
$28,400
$34,400
$34,400
$83,400
PV factor @ 8%
1
0.9259
0.8573
0.7938
0.735
0.6806
0.6312
0.5835
0.5403
0.5003
0.463
Present Value
($240,000)
$31,850.96
$29,491.12
$27,306.72
$22,638.00
$23,412.64
$21,713.28
$16,571.40
$18,586.32
$17,210.32
$38,614.20
Net Present Value
$7,395
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