Down Under Boomerang, Inc., is considering a new three-year expansion project th

Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.91 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,150,000 in annual sales, with costs of $845,000. The tax rate is 30 percent and the required return is 11 percent. The project requires an initial investment in net working capital of $370,000, and the fixed asset will have a market value of $245,000 at the end of the project. What is the project's Year 0 net cash flow? Year 1? Year 2? Year 3? what is the NPV?

Explanation / Answer

The Cash Flows are as follows:

Year 0 = (2,910,000 + 370,000) = (3,280,000)

The Cash flow at Year 0 is increased due to investment in Net working capital

Cash inflow for Year 1 &Year 2 is same, as calculated below :

OCF = (Sales- Cost)(1-Tax Rate)+Depreciation*Tax rate

Depreciation = 2,910,000/3 = $ 970,000

OCF = (2,150,000- 845,000) (1-0.30) + 970,000 * 0.30

OCF = 913,500 + 291,000 = $ 1,204,500

In Year 3, the Cash flow is calculated as below, as it will include Recovery of NWC, Salvage value:

Year 3 = 1,204,500 + 370,000 + 245,000 – (245,000) (0.30)

= 1,204,500 + 370,000 + 245,000 – 73,500

Year 3 = $ 1,746,000

NPV = (3,280,000) + 1,204,500 * (1/1.11) + 1,204,500* (1/1.11)^2 + 1,746,0000* (1/1.11)^3

= (3,280,000) + 1085135.14 + 977599.22+ 1276660.15

= $ 59,394.51

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