1.Maple Media is considering a proposal to enter a new line of business. In revi

Question

1.Maple Media is considering a proposal to enter a new line of business. In reviewing the prorposal, the company's CFO is considering the following facts: -The new business will require the company to purchase additional fixed assets that will cost $600000 at t=0. For tax and accounting purposes, these costs will be depreciated on a straight-line basis over three years. (Annual depreciation will be $200000 per year at t=1,2,and3) -At the end of three years, the company will get out of the business and will sell the fixed assets at a salvage value of $100000. -The project will require a $500000 increase in net operating working capital at t=0, which will be recovered at t=3. -the Company's marginal tax rate is 35 percent. -The new business is expected to generate $2million in sales each year (at t=1,2, and 3). The operating costs excluding depreciation are expected to be $1.4 million per year.The projects's cost of capital is 12 percent. What is the project's net present value(NPV)?

Explanation / Answer

Net cash flows = Sales - Operating costs

= 2 million - 1.4 million i.e 0.60 million or 600000

Cash flows net of tax = 0.60(1-Tax rate)

= 0.60(1-0.35) i.e 0.39 or 390000

Salvage value net of tax = 100000*0.65 i.e 65000

Tax saving on depreciation = 200000*0.35 i.e 70000

Particulars Year Cash Flows PVF PV Initial cost 0 -600000 1 -600000 Working Capital 0 -500000 1 -500000 Income ( Net of tax) 1 to 3 390000 2.4018 936702 Tax saving on depreciation 1 to 3 70000 2.4018 168126 Salvage value ( net of tax) 3 65000 0.71178 46265.7 Working Capital 3 500000 0.71178 355890 Net Present Value 406983.7

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