Green Monstah Landscaping Corp. is considering some new equipment whose data are
ID: 2635044 • Letter: G
Question
Green Monstah Landscaping Corp. is considering some new equipment whose data are shown below. THe equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the equipment would be sold. Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV?
Explanation / Answer
Solution:
Step 1: Calculation of initial investment:
Net investment in fixed assets = $70,000
New working capital required = $10,000
Total initial investment = $80,000
Step 2: Calculation of After-tax cash flows
Year 1 Year 2 Year 3
Sales
$ 67,000.00
$ 67,000.00
$ 67,000.00
Less: Op.costs excl. depr.
$ 30,000.00
$ 30,000.00
$ 30,000.00
Less: Depreciation
$ 23,333.33
$ 23,333.33
$ 23,333.33
EBIT
$ 13,666.67
$ 13,666.67
$ 13,666.67
Less: Interest expense
$ -
$ -
$ -
Earnings before taxes
$ 13,666.67
$ 13,666.67
$ 13,666.67
Less: Taxes at 35%
$ 4,783.33
$ 4,783.33
$ 4,783.33
Earnings after taxes
$ 8,883.33
$ 8,883.33
$ 8,883.33
Add: Depreciation expense
$ 23,333.33
$ 23,333.33
$ 23,333.33
Cash flows after taxes
$ 32,216.67
$ 32,216.67
$ 32,216.67
Step 3: Calculation of Terminal cash flows:
Book value of the equipment at the end of year 3 = 0
Therefore, the entire salvage value is profitable and taxable.
Salvage value = $5,000
Tax on profit on salvage value = $5,000 x 35% $1,750
After tax salvage value = $5,000- $1,750 = $3,250
Terminal values:
Working capital released = $10,000
After-tax salvage value = $3,250
Total terminal cash flows = $13,250
Step 4: Calculation of NPV:
Year
PV factor
Cash
PV of cash
at 10%
flows
flows
0
1.0000
$ (80,000.00)
$ (80,000.00)
1
0.9091
$ 32,216.67
$ 29,287.88
2
0.8264
$ 32,216.67
$ 26,625.34
3
0.7513
$ 32,216.67
$ 24,204.86
3
0.7513
$ 13,250.00
$ 9,954.92
NPV =
$ 10,073.00
Therefore, the NPV is $10,073.
This project can be accepted because NPV>0.
Sales
$ 67,000.00
$ 67,000.00
$ 67,000.00
Less: Op.costs excl. depr.
$ 30,000.00
$ 30,000.00
$ 30,000.00
Less: Depreciation
$ 23,333.33
$ 23,333.33
$ 23,333.33
EBIT
$ 13,666.67
$ 13,666.67
$ 13,666.67
Less: Interest expense
$ -
$ -
$ -
Earnings before taxes
$ 13,666.67
$ 13,666.67
$ 13,666.67
Less: Taxes at 35%
$ 4,783.33
$ 4,783.33
$ 4,783.33
Earnings after taxes
$ 8,883.33
$ 8,883.33
$ 8,883.33
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