Sabina Bookstores is thinking about expanding its facilities. In considering the
ID: 2757321 • Letter: S
Question
Sabina Bookstores is thinking about expanding its facilities. In considering the expansion, Sabina's finance staff has obtained the following information; the expansion will require the company to purchase initially (t=0) $5 million of equipment (this amount includes shipping and installation). The equipment will be depreciated over the following four years at the following rates (3 year MACRS class) t=1 33% t=2 45% t=3 15% t=4 7%. The expansion will require the company to increase its net operating working capital by $500,000 today (t=0). This net operating working capital will be recovered at the end of four years (t=4). The equipment is expected to have a salvage value of $2 million at the end of four years. The company's operating costs, excluding depreciation, are expected to be 50% of the company's annual sales. The expansion will increase the company's dollar sales. The projected increase all relative in current sales are Year 1: $3 million Year 2: $3.5 million Year 3: $4.5 million Year 4: $4 million. The company's tax rate is 40% and the other divisions are expected to have a positive tax liabilities throughout the project's life. The discount rate is 10%. What is the NPV?
Explanation / Answer
Depreciation Schedule Depreciable Basis: $5,000,000
MACRS
Annual
Year
Percent
Depreciation
1
0.33
$1,650,000
2
0.45
2,250,000
3
0.15
750,000
4
0.07
350,000
0
1
2
3
4
Cost
($5,000,000)
Working capital
(500,000)
Sales
$3,000,000
$3,500,000
$4,500,000
$4,000,000
Operating costs, excl.
depr. (50%)
1,500,000
1,750,000
2,250,000
2,000,000
Gross Profit
$1,500,000
$1,750,000
$2,250,000
$2,000,000
Depreciation
(1,650,000)
(2,250,000)
(750,000)
(350,000)
Operating income
($ 150,000)
($ 500,000)
$1,500,000
$1,650,000
Taxes (40%)
(60,000)
(200,000)
600,000
660,000
After-tax income
($ 90,000)
($ 300,000)
$ 900,000
$ 990,000
Plus: Depreciation
1,650,000
2,250,000
750,000
350,000
After-tax income
cash flow
$1,560,000
$1,950,000
$1,650,000
$1,340,000
Recovery of working capital
500,000
Net cash flow
($5,500,000)
$1,560,000
$1,950,000
$1,650,000
$1,840,000
NPV = PV of Cash inflow - PV of Cash out flow
NPV = $ 5,524,610 - $5,500,000 = $24,610
MACRS
Annual
Year
Percent
Depreciation
1
0.33
$1,650,000
2
0.45
2,250,000
3
0.15
750,000
4
0.07
350,000
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