LM Company is considering investing in a new project that will generate cash inf

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 cost $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 will 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 (NPV) of the new project.

Explanation / Answer

Solution:

Initital Cash outflows = Investment in machine + Working captial investment = $200,000 + $40,000 = $240,000

NPV = PV of cash inflows - Iniital Cash outflows

= $250,155.39 - $240,000 = $10,155.39

Computation of Present value after tax cash Inflows Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Total Cash Inflows $45,000.00 $45,000.00 $45,000.00 $45,000.00 $45,000.00 $45,000.00 $45,000.00 $45,000.00 $45,000.00 $45,000.00 Less: Depreciation $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 Less: repair $6,000.00 $10,000.00 Income before taxes $26,500.00 $26,500.00 $26,500.00 $20,500.00 $26,500.00 $26,500.00 $16,500.00 $26,500.00 $26,500.00 $26,500.00 Less: Income Tax (40%) $10,600.00 $10,600.00 $10,600.00 $8,200.00 $10,600.00 $10,600.00 $6,600.00 $10,600.00 $10,600.00 $10,600.00 Income after taxes $15,900.00 $15,900.00 $15,900.00 $12,300.00 $15,900.00 $15,900.00 $9,900.00 $15,900.00 $15,900.00 $15,900.00 Add: Depreciation $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 $18,500.00 Add: Salvage value of machine $15,000.00 Add: recovery of working capital $40,000.00 Annual cash inflows $34,400.00 $34,400.00 $34,400.00 $30,800.00 $34,400.00 $34,400.00 $28,400.00 $34,400.00 $34,400.00 $89,400.00 PV Factor 0.92593 0.85734 0.79383 0.73503 0.68058 0.63017 0.58349 0.54027 0.50025 0.46319 Present value of cash inflows $31,851.85 $29,492.46 $27,307.83 $22,638.92 $23,412.06 $21,677.84 $16,571.13 $18,585.25 $17,208.56 $41,409.50 $250,155.39

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