ABC Corporation is considering an expansion project. To date they have spent $15

ID: 2707475 • Letter: A

Question

ABC Corporation is considering an expansion project. To date they have spent $150,000 investigating the viability of the project and have decided to proceed. The proposed project will cost $1,500,000 in addition to the $150,000 that was spent on the feasibility study. The project will be depreciated over a 3 year MACRS class life.

MACRS

Depreciation

Year Rates

1 0.33

2 0.45

3 0.15

4 0.07

If the project is undertaken the company will need to increase its inventories by $500,000, and its accounts payable will rise by $200,000. The company will realize an additional $1,500,000 in sales over each of the next four years. The company

Explanation / Answer

YEARS

CASHFLOWS AFTER TAX

PRESENT VALUE @ 12%

(1500000) + working capital

(1500000+300000)

=(1800000)

(1800000)

(1500000-750000-495000)*0.66 + 495000

=663300

592232

(1500000-750000-675000)*0.66 + 675000

=724500

577567

(1500000-750000-225000)*0.66+ 225000 + sale of project

=571500 + 134700

=706200

502659

(1500000-750000)*0.66 + RECOVERY OF WORKING CAPITAL

= 495000 + 300000

=795000

470704

NPV=

343162

CALCULATION OF DEPRECIATION

YEAR -1

1500000*0.33 =495000

YEAR-2

1500000*0.45 =675000

YEAR-3

1500000*0.15 =225000

TOTAL

1395000

NOTE:-

1]COST SPENT ON FEASIBILITY STUDY OF THE PROJECT IS A SUNK COST,THEREFORE IRRELEVANT.

2]CASHFLOW = {SALES-COST-DEPRECIATION]*(1-t) + DEPRECIATION

3]BOOK VALUE OF THE PROJECT AT t =3,

=1500000-1395000

=105000

SALVAGE VALUE OF THE PROJECT AT t = 3, = 150000

Profit ON SALE = 150000-105000

=45000

TAX @ 34% = 45000*0.34

=15300

NET CASHINFLOW FROM SALE OF PROJECT AT t= 3, = 150000