Southern Cotton Corp. is considering opening a packaging facility outside of Atl

Question

Southern Cotton Corp. is considering opening a packaging facility outside of Atlanta. They have already signed a contract to purchase property to build the factory, and the payment of $500,000 is due today. The new factory would require an investment of $450,000 today and is expected to be in operation for 4 years. The factory would be depreciated straight-line to $50,000 over the 4-year life of the project, and at the end of year 4, the factory will be sold for $100,000. Annual revenues for the new factory are expected to be $355,000, and annual costs are expected to be $182,000. The tax rate is 30%, and the appropriate discount rate for the project is 14.4%. Based on the information given, what is NPV of the packaging facility project?

Explanation / Answer

Hi,

Please find the correct and detailed answer as follows:

Initial Investment = - 450000

Annual Depreciation = (Original Investment - Salvage Value)/Life of the Facility = (450000 - 50000)/4 = 100000

Annual Cash Inflow = (Sales - Costs - Depreciation)*(1- Tax Rate) + Depreciation*Tax Rate = (355000-182000 -100000)*(1-0.3) + 100000 = 151100

Terminal Year Cash Inflow (Year 4) = Annual Cash Inflow + After Tax Cash Flow

After Tax Cash Flow = Sales Value after 4 Years - Tax Rate*(Sales Value after 4 Years - Salvage Value) = 100000 - 30%*(100000 - 50000) = 85000

Terminal Year Cash Inflow (Year 4) = 151100 + 85000 = 236100

---------------------------------------------

NPV = -450000 + 151100/(1+.144)^1 + 151100/(1+.144)^2 + 151100/(1+.144)^3 + 236100/(1+.144)^4 = 36302.73 or 36303

Answer is 36302.73 or 36303.

Notes:

1) Terminal Year Cash Inflow includes both Annual Cash Inflow and After Tax Cash Flow realized from Sale of Asset at the end of its useful life.

2) Tax on Capital Gain is deducted while calculating After Tax Cash Flow. Capital Gain is the difference between Sales Value after 4 Years and Salvage Value.

Thanks.

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