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 $4.320 million. The fixed asset will be depreciated straight-line to zero over 3 years. At the end of the project, the asset will be sold for $336,000. Net working capital would be $480,000 at time 0 and remain at $480,000 for all years except for year 3. Net working capital for year 3 would be 0. In other words, the level of NWC is expected to be $480,000 at every point in time during the project except for in 3 years, when the level of NWC is expected to be $0. The project is estimated to generate $3,840,000 in annual sales, with annual costs of $1,536,000. The tax rate is 31 percent and the cost of capital for the project is 17 percent. The NPV for this project is

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $4.320 million. The fixed asset will be depreciated straight-line to zero over 3 years. At the end of the project, the asset will be sold for $336,000. Net working capital would be $480,000 at time 0 and remain at $480,000 for all years except for year 3. Net working capital for year 3 would be 0. In other words, the level of NWC is expected to be $480,000 at every point in time during the project except for in 3 years, when the level of NWC is expected to be $0. The project is estimated to generate $3,840,000 in annual sales, with annual costs of $1,536,000. The tax rate is 31 percent and the cost of capital for the project is 17 percent. The NPV for this project is

Explanation / Answer

The annual profit is 3840000 - 1536000 = 2,304,000

Reduce depriciation of 4320000/3 = 1,440,000

Tax = 0.31 * ( 2304000 - 1440000 ) = 267,840

Net cash inflow in each year is 2304000 - 267840 = 2,036,160

Initial investment is 4320000 + 480000 = 4800000

cash flows

year 0, -4800000

year 1, + 2036160

year 2, +2036160 + 480000

year 3, +2036160 + 336000

NPV is year 0 + year1/1.17 + year2/1.17^2 + year3/1.17^3

NPV is 259,503.53.

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