Thomson Media is considering some new equipment whose data are shown below. The
ID: 2756932 • Letter: T
Question
Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV?
10.0%
$70,000
$10,000
33.333%
$80,000
$30,000
$5,000
35.0%
$32,952
$33,263
$35,439
$26,735
$31,087
WACC10.0%
Net investment in fixed assets (depreciable basis)$70,000
Required net operating working capital$10,000
Straight-line depreciation rate33.333%
Annual sales revenues$80,000
Annual operating costs (excl. depreciation)$30,000
Expected pre-tax salvage value$5,000
Tax rate35.0%
Explanation / Answer
Calculation of NPV:
Initial Investment:
Particulars
Amount ($)
Net Investment in fixed assets
-70000
Requirement of net working capital
-10000
Total
-80000
During the year cash flows:
Particulars
Amount ($)
Annual Sales Revenue
80000
Less: Annual Operating Costs (excl. depreciation)
-30000
Earnings before depreciation and tax
50000
Less: Depreciation (70000 * 33.333%)
-23333
Earnings before Tax
26667
Less: Taxes (35%)
-9333
Earnings after tax
17334
Add: Depreciation
23333
Cash Flow after Tax
40667
Terminal Cash Flows:
Particulars
Amount ($)
Pre tax Salvage Value
5000
Salvage Value after Tax (5000 * (1-0.35))
3250
Recovery of working capital
10000
Total
13250
Calculation of NPV:
Year
Cash Flow
PVF (10%)
PV of Cash Flow
0
-80000
1
-80000
1
40667
0.9091
36970
2
40667
0.8264
33607
3
40667
0.7513
30553
3
13250
0.7513
9955
NPV
31085
NPV = $31085 (approx.)
Correct answer is e) $31087
Particulars
Amount ($)
Net Investment in fixed assets
-70000
Requirement of net working capital
-10000
Total
-80000
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