Summer Tyme, Inc., is considering a new 3-year expansion project that requires a

Question

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $5.886 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $457,800. The project requires an initial investment in net working capital of $654,000. The project is estimated to generate $5,232,000 in annual sales, with costs of $2,092,800. The tax rate is 30 percent and the required return on the project is 14 percent.

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $5.886 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $457,800. The project requires an initial investment in net working capital of $654,000. The project is estimated to generate $5,232,000 in annual sales, with costs of $2,092,800. The tax rate is 30 percent and the required return on the project is 14 percent.

Explanation / Answer

Time line 0 1 2 3 Cost of equipment -5886000 Installation cost 0 Total investment in new machine -5886000 Net working capital -654000 =Initial Investment outlay -6540000 sales-cost 3139200 3139200 3139200 -Depreciation MACR Rate* total investment -1962000 -1962000 -1962000 = 1177200 1177200 1177200 -taxes =(savings- depreciation)*(1-tax) 824040 824040 824040 +Depreciation 1962000 1962000 1962000 =after tax operating cash flow 2786040 2786040 2786040 Reversal of Net working capital 654000 Proceeds from sale of assets =selling price*(1 - tax rate) 320460 +Salvage book value * tax rate 0 Terminal year non operating cash flows 974460 Total Cash flow for the period -6540000.00 2786040.00 2786040.00 3760500.00 Discount factor =(1+discount rate)^n 1 1.14 1.2996 1.481544 Discount rate= 14% Discounted cash flows -6540000 2443894.74 2143767.3 2538230.39 NPV= Sum of discounted cash flows 585892.437

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