Keiper, Inc., is considering a new three-year expansion project that requires an

Question

Keiper, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.58 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,040,000 in annual sales, with costs of $735,000. The project requires an initial investment in net working capital of $260,000, and the fixed asset will have a market value of $280,000 at the end of the project. If the tax rate is 34 percent, what is the project

Keiper, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.58 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,040,000 in annual sales, with costs of $735,000. The project requires an initial investment in net working capital of $260,000, and the fixed asset will have a market value of $280,000 at the end of the project. If the tax rate is 34 percent, what is the project

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Initial Investment = -2580000 - 260000 = -2840000

Annual Operating Cash Flows = (Sales - Costs - Depreciation)*(1-Tax Rate) + Depreciation = (2040000 - 735000 - 2580000/3)*(1-.34) + 2580000/3 = 1153700

Terminal Year Cash Flow (Year 3) = Annual Operating Cash Flow + Recovery of Working Capital + Market Value*(1-Tax Rate) = 1153700 + 260000 + 280000*(1-.34) = 1598500

Statement of Cash Flows
:

Part B:

NPV = -2840000 + 1153700/(1+.15)^1 + 1153700/(1+.15)^2 + 1598500/(1+.15)^3 = $86620.04

Notes:

Investment in working capital will get recovered at the end of project's useful life.

Thanks.

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