You are in charge of evaluating a new machine that, if accepted, would create a

Question

You are in charge of evaluating a new machine that, if accepted, would create a project for your firm. The project is supposed to be five years in duration. The machine would generate sales of $45,000 during the first year of the project. This amount would increase by 8% each year for the remaining 4 years, all incrementally over the respective previous year. Costs are expected to be 40% of sales. The firm tax rate is 35%.

The machine has a cost of $50,000, and can be depreciated as a 3-year property class. In addition, the project would require an increase in NWC of $15,000, which cannot be depreciated. However, you can recover 50% of this amount at the end of the project. In addition, at the end of the project, you feel you can sell the machine for $10,000 at the end.

If the project has a required rate of return of 8%, what is the NPV of this project?

Explanation / Answer

Present value of cash inflow = 68277

Present value of cash outflow = 50000

Net present value = 18277

year 1 year 2 year 3 year 4 year 5 Sales 45000 48600 52488 56687.04 61222 Cost 18000 19440 20995 22675 24489 Profit 27000 29160 31493 34012 36733 Less- depreciation 16665 14817 2742 1169 Net profit 10335 14343 28751 32843 36733 Less- tax @35% 3617 5020 10063 11495 12857 Profit after tax 6718 9323 18688 21348 23877 Add- depreciation 16665 14817 2742 1169 Cash flow 23383 24140 21430 22517 23877 Less- Increase in NWC -15000 -15000 -15000 7500 Sale proceeds of machine 10000 Net cash inflow 23383 9140 6430 7517 41377 PVF 0.9259 0.8573 0.7938 0.7350 0.6806 Present value 21651 7836 5104 5525 28160

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