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 $2.40 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $1,980,000 in annual sales, with costs of $675,000. The tax rate is 34 percent and the required return is 18 percent. The project requires an initial investment in net working capital of $200,000, and the fixed asset will have a market value of $310,000 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

Initial Asset Value, A = $2,400,000

As it is straight line depreciation with period of 3 years so depreciation will equal for each of the 3 years.

So Year 1 Depreciation, D1 = A/3 = $1,000,000;

Similarly D2 = A/3 = $1,000,000; D3 = $1,000,000

Annual Sales, S =$1,980,000; Annual Cost , C = $675,000; Salvage Value of Asset at end of year 3, Sal = 310,000; Initial Working Capital Investment, I = $200,000; Tax Rate, T =0.34; Required Return, r=18%

So Year 0 Cash Flows, CF0 = -A - I = - $2,600,000

Year 1 Cash Flows, CF1 = (S-C-D1)*(1-T)+D1= $ 1,602,680

Year 2 Cash Flows, CF2 = (S-C-D2)*(1-T)+D2 = $ 1,602,680;

Year 3 Cash Flows, CF3 = (S-C-D3+Sal)*(1-T)+D3+I = $1,802,580;

So Net Present Value = CF0+CF1/(1+r) +CF2/(1+r)2 +CF3/(1+r)3

So NPV = -2,600,000+1018050.85+862754.96+977400.32 = $258,206.12

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