Down Under Boomerang, Inc., is considering a new three-year expansion project th

Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $1.4 million. The fixed asset will be depreciated straight-line to zero over its three year tax life, after which it will be worthless. The project is estimated to generate $1,120,000 in annual sales, with costs of $480,000. The tax rate is 35 percent and the required return is 12 percent. The project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of the project.

What is the project

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $1.4 million. The fixed asset will be depreciated straight-line to zero over its three year tax life, after which it will be worthless. The project is estimated to generate $1,120,000 in annual sales, with costs of $480,000. The tax rate is 35 percent and the required return is 12 percent. The project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of the project.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A: Annual Cash Flow for Each Year:

Operating Cash Flow = (Sales - Costs)*(1-Tax Rate) + Tax Rate*Depreciation = (1120000 - 480000)*(1-.35) + (1400000/3)*.35 = 579333.33

Net Cash Flow (Year 0) = -1400000 - 285000 = -1685000 (amount of initial investment + working capital)

Annual Cash Inflow (Year 1) = 579333.33

Annual Cash Inflow (Year 2) = 579333.33

Annual Cash Inflow (Year 3) = 579333.33 +285000 + 225000*(1-.35) = 1010583.33

Part B:

NPV = - 1685000 + 579333.33/(1+.12)^1 + 579333.33/(1+.12)^2 + 579333.33/(1+.12)^3 + 285000/(1+.12)^3 + 225000*(1-.35)/(1+.12)^3 = 13416.14 or 13416.

Thanks.

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