Litchfield Design is evaluating a 3-year project that would involve buying a new

Question

Litchfield Design is evaluating a 3-year project that would involve buying a new piece of equipment for 370,000 dollars today. The equipment would be depreciated straight-line to 50,000 dollars over 2 years. In 3 years, the equipment would be sold for an after-tax cash flow of 61,000 dollars. In each of the 3 years of the project, relevant revenues are expected to be 265,000 dollars and relevant costs are expected to be 79,000 dollars. The tax rate is 50 percent and the cost of capital for the project is 7.05 percent. What is the NPV of the project?

Explanation / Answer

Equipment is depreciated straight line to $50000 over 2 years. It means for 2 years Depreciation = $370000 - $50000 = $320000 For 1 year depreciation = $320000 /2 = $160000 Calculation of operating Cash Inflow for 3 years Year Revenue Cost Depreciation Profit before Tax Tax @ 50% Profit after tax Operating cash inflow In $ In $ In $ In $ In $ In $ In $ A B C D = A-B-C E F = D-E F + C 1 265000 79000 160000 26000 13000 13000 173000 2 265000 79000 160000 26000 13000 13000 173000 3 265000 79000 186000 93000 93000 93000 Calculation of NPV Year Cash Flow PV Factor = 1/(1+r)^n Present Value In $ In $ 0 -370000 1                -3,70,000 1 173000 0.934142924                  1,61,607 2 173000 0.872623002                  1,50,964 3 93000 0.815154603                      75,809 Salvage value 61000 0.815154603                      49,724 Net Present value of the Project                      68,104 n = no.of years r = cost of capital = 0.0705

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