Summer Tyme, Inc., is considering a new 2-year expansion project that requires a

Question

Summer Tyme, Inc., is considering a new 2-year expansion project that requires an initial fixed asset investment of $3.726 million. The fixed asset will be depreciated straight-line to zero over 2 years, after which time it will be worthless and hauled away for an after-tax cash flow of $0. In each year, the project is estimated to generate $3,312,000 in annual sales, with annual costs of $1,324,800. If the tax rate is 35 percent and the cost of capital for the project is 14 percent, the NPV for this project is $ ?

Explanation / Answer

Here is our information breakdown: -2 year project -Initial Cost: -$3.726 million -Straight Line Depreciation with 0 salvage value -Annual Revenue: $3,312,000 -Annual Expense: $1,324,800 -Tax Rate: 35% -Cost of Capital: 14% First, I am going to find annual depreciation: ($3,726,000 - 0 )/ 2 = 1,863,000 Now, I am going to break it down by time 0,1,2 CFs and discount them back to time 0: Year 0 CF: -3,726,000 PV(CF_0) = -3,726,000 Year 1 CF: (3,312,000 - 1,324,800 - 1,863,000) * (1-0.35) + 1,863,000 = $1,943,730 PV(CF_1) = 1,943,730 / (1+0.14)^1 = $1,705,025.32 Year 2 CF: (3,312,000 - 1,324,800 - 1,863,000) * (1-0.35) + 1,863,000 = $1,943,730 PV(CF_2) = 1,943,730 / (1+0.14)^2 = $1,495,637.12 NPV = -3,726,000 + 1,705,025.32 + 1,495,637.12 = -525,337 (ANSWER) The formula used in these are pretty standard and should be pretty self-explanatory (if you have questions about them, let PM me)

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