7.Cochrane, Inc., is considering a new three-year expansion project that require

Question

7.Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.1 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,150,000 in annual sales, with costs of $1,140,000.The project requires an initial investment in net working capital of $150,000, and the fixed asset will have a market value of $175,000 at the end of the project. Assume that the tax rate is 35 percent and the required return on the project is 14 percent.

What are the net cash flows of the project for the following years? (Do not include the dollar signs ($). Negative amounts should be indicated by a minus sign. Enter your answers in dollars, not millions of dollars (e.g., 1,234,567).)

What is the NPV of the project? (Do not include the dollar sign ($). Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).)

What are the net cash flows of the project for the following years? (Do not include the dollar signs ($). Negative amounts should be indicated by a minus sign. Enter your answers in dollars, not millions of dollars (e.g., 1,234,567).)

Explanation / Answer

Definition of 'Net Present Value - NPV' The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative. For example, if a retail clothing business wants to purchase an existing store, it would first estimate the future cash flows that store would generate, and then discount those cash flows into one lump-sum present value amount, say $565,000. If the owner of the store was willing to sell his business for less than $565,000, the purchasing company would likely accept the offer as it presents a positive NPV investment. Conversely, if the owner would not sell for less than $565,000, the purchaser would not buy the store, as the investment would present a negative NPV at that time and would, therefore, reduce the overall value of the clothing company........................................................................................................Definition of 'Operating Cash Flow - OCF' In accounting, a measure of the amount of cash generated by a company's normal business operations. Operating cash flow is important because it indicates whether a company is able to generate sufficient positive cash flow to maintain and grow its operations, or whether it may require external financing. OCF is calculated by adjusting net income for items such as depreciation, changes to accounts receivable and changes in inventory. Financial analysts sometimes prefer to look at cash flow metrics because it strips away certain accounting effects and is thought to provide a clearer picture of the current reality of the business operations. For example, booking a large sale provides a big boost to revenue, but if the company is having a hard time collecting the cash, then it is not a true economic benefit to the company. On the other hand, a company may be highly profitable on a cash flow basis, but may not have a low net income if it has a lot of fixed assets and uses accelerated depreciation calculations.

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