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 $2.82 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,120,000 in annual sales, with costs of $815,000. The tax rate is 30 percent and the required return is 12 percent. The project requires an initial investment in net working capital of $340,000, and the fixed asset will have a market value of $230,000 at the end of the project.

What is the project's Year 0 net cash flow? Year 1? Year 2? Year 3?

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.82 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,120,000 in annual sales, with costs of $815,000. The tax rate is 30 percent and the required return is 12 percent. The project requires an initial investment in net working capital of $340,000, and the fixed asset will have a market value of $230,000 at the end of the project.

Explanation / Answer

Annual depreciation = 2,820,000 /3 = $ 940,000

Annual income before tax = 2,120,000 - 815,000 -9,40,000 =365,000

Tax @ 30% = 365,000 x 30% = $ 109,500

Annual net income = 365,000 - 109,500 = $ 255,500

Therefore annual cash flows = 255,500 + 940,000 = $ 1,195,500

Year Initial investment Annual cash inflows Residual value of asset Net cash flows PV factor at 12% Present Value $ 0 Initial Investment (2,820,000) 1 0 Net working capital (340,000) (3,160,000) 1 (3,160,000) 1 Annual cash inflows 1,195,500 1,195,500 0.893 1,067,582 2 1,195,500 1,195,500 0.797 952,814 3 1,195,500 230,000 1,425,500 0.712 1,014,956 NPV (124,648)

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