Summer Tyme, Inc., is considering a new 3-year expansion project that requires a

Question

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $1.566 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will be sold for $121,800. The project requires an initial investment in net working capital of $174,000, all of which is recovered at the end of the project. The project is estimated to generate $1,392,000 in annual sales, with costs of $556,800. The tax rate is 35 percent and the required return on the project is 10 percent.

What is the project's year 1, 2 and 3 net cash flow? HINT: This will include OCF.

Explanation / Answer

The project is an expansion project

Fixed investment = initial fixed asset investment + net working capital = 1566000 + $174000 =$1740000

Year 1and year 2 cashflows = (sales - cost of sales)*(1-T) +(annual depreciation*T) = (1392000-556800)*0.65 + (1566000/3)*0.35 = $725580

Year 3 cashflows =(sales - cost of sales)*(1-T) +(annual depreciation*T) + market value + NetWc –T(market value – book value) = $725580 + 121800 +174000 – (0.35*121800) = $978750

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