A project requires an initial investment in equipment of $90,000 and then requir

Question

A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0). You expect the project to produce sales revenue of $120,000 per year for three years. You estimate manufacturing costs at 60% of revenues. (Assume all revenues and costs occur at year-end, i.e., t = 1, t = 2, and t = 3.) The equipment depreciates using straight-line depreciation over three years. At the end of the project, the firm can sell the equipment for $10,000 and also recover the investment in net working capital. The corporate tax rate is 30% and the cost of capital is 15%. Calculate the NPV of the project:

$3,840. $8,443. $-2,735. $7,342.

Explanation / Answer

Here is the excel solution. I cannot copy the formulas here but am sure of the solution:

So the solution is B. $8,443.

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Depreciable Cost $90,000 Depreciation Rate 0.333333 Annual Depreciation $30,000 Year 0 1 2 3 Revenue $120,000 $120,000 $120,000 Less: Costs $72,000 $72,000 $72,000 Less: Depreciation $30,000 $30,000 $30,000 EBIT $18,000 $18,000 $18,000 Less: Taxes @ 30% $5,400 $5,400 $5,400 Net Income $12,600 $12,600 $12,600 1) Operating Cash Flow Year 0 1 2 3 EBIT $18,000 $18,000 $18,000 Add: Depreciation $30,000 $30,000 $30,000 Less: Taxes $5,400 $5,400 $5,400 Operating Cash Flow $42,600 $42,600 $42,600 2) Net Working Capital Year 0 1 2 3 Initial NWC ($10,000) NWC Recovery $10,000 Changes in NWC ($10,000) $0 $0 $10,000 3) Capital Spending Year 0 1 2 3 Initial Outlay ($90,000) After-Tax Salvage $7,000 Capital Spending ($90,000) $0 $0 $7,000 Projected Total Cash Flows Year 0 1 2 3 Operating Cash Flow $0 $42,600 $42,600 $42,600 Changes in NWC ($10,000) $0 $0 $10,000 Capital Spending ($90,000) $0 $0 $7,000 Total Project Cash Flow ($100,000) $42,600 $42,600 $59,600 PV Factor at 15% 1 0.869565 0.756143667 0.65751623 PV of Cash Flows ($100,000) $37,043 $32,212 $39,188 NPV $8,443

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