Thomson Media is considering some new equipment whose data are shown below. The
ID: 2776851 • 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, some new 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?
WACC
10.0%
Net investment in fixed assets (depreciable basis)
$70,000
Required new working capital
$10,000
Straight-line deprec. rate
33.333%
Sales revenues, each year
$75,000
Operating costs (excl. deprec.), each year
$30,000
Expected pretax salvage value
$5,000
Tax rate
35.0%
A
$20,762
B
$21,854
C
$23,005
D
$24,155
E
$25,363
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, some new 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?
WACC
10.0%
Net investment in fixed assets (depreciable basis)
$70,000
Required new working capital
$10,000
Straight-line deprec. rate
33.333%
Sales revenues, each year
$75,000
Operating costs (excl. deprec.), each year
$30,000
Expected pretax salvage value
$5,000
Tax rate
35.0%
A
$20,762
B
$21,854
C
$23,005
D
$24,155
E
$25,363
Explanation / Answer
Annual Cash Flow = (Sales revenues, each year - Operating costs (excl. deprec.), each year)*(1-tax rate) + Annual Depreciation * tax rate
Annual Cash Flow = (75000-30000)*(1-35%) + (70000*33.333%)*35%
Annual Cash Flow = $ 37,417
pretax salvage value = 5000
Postax salvage value = pretax salvage value*(1-tax rate)
Postax salvage value = 5000*(1-35%)
Postax salvage value = 3250
Terminal Value = Postax salvage value + working capital recovered
Terminal Value = 3250 + 10000
Terminal Value = 13250
Initial Investment = Net investment in fixed assets (depreciable basis) + Required new working capital
Initial Investment = 70000 + 10000
Initial Investment = $ 80000
Project’s NPV = -Initial Investment + Annual Cash Flow/(1+r) + Annual Cash Flow/(1+r)^2 + Annual Cash Flow/(1+r)^3 + Terminal Value/(1+r)^3
Project’s NPV = -80000 + 37,417/1.1 + 37,417/1.1^2 + 37,417/1.1^3 + 13250/1.1^3
Project’s NPV = $ 23005
Answer
C) $23,005
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