As a financial manager for a company, you are considering a proposed project whi

Question

As a financial manager for a company, you are considering a proposed project which requires an investment of $600,000 in fixed assets. The project has a five-year useful life but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $100,000, which can be fully recovered at the end of the project’s life. The marginal tax rate of your company is 35%, and the project discount rate is 12%. The annual sales and operating cost excluding depreciation are estimated to be $600,000 and $350,000 respectively. The project can be scrapped for a market value of $50,000 (before tax) at the end of its life. Should the project be accepted? SUPPORT YOUR ANSWER WITH NECESSARY COMPUTATIONS.

Explanation / Answer

Depreciation rates: Year 1 = 33.33%, Year 2 = 44.45%, Year 3 = 14.81%, Year 4 = 7.41%

Statement of cash flows:

NPV = $129880.43

Since NPV is postitive, the project should be accepted.

Year 0 1 2 3 4 5 Initial investment -600000 Investment in Net working capital -100000 Net Annual savings net of tax 162500 162500 162500 162500 162500 Tax savings on depreciation 69993 93345 31101 15561 Reversal of net working capital 100000 Scrap value net of tax 32500 Annual cash flows -700000 232493 255845 193601 178061 295000 PVF@12% 1 0.893 0.797 0.712 0.636 0.567 Present value -700000 207616.25 203908.47 137843.91 113246.80 167265

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