Howell Petroleum is considering a new project that complements its existing busi
ID: 2778220 • Letter: H
Question
Howell Petroleum is considering a new project that complements its existing business. The machine required for the project costs $3.89 million. The marketing department predicts that sales related to the project will be $2.59 million per year for the next four years, after which the market will cease to exist. The machine will be depreciated down to zero over its four-year economic life using the straight-line method. Cost of goods sold and operating expenses related to the project are predicted to be 25 percent of sales. Howell also needs to add net working capital of $240,000 immediately. The additional net working capital will be recovered in full at the end of the project’s life. The corporate tax rate is 35 percent. The required rate of return for Howell is 15 percent. What is the value of the NPV for this project?
Explanation / Answer
Calculation of NPV of the project:
Year
Cash Flows (CF)
PVF(15%)
PV = CF*PVF
Machine Cost
0
$ (3,890,000.00)
1.00000
$ (3,890,000.00)
Investment in net working capital
0
$ (240,000.00)
1.00000
$ (240,000.00)
Investment in net working capital recovered
4
$ 240,000.00
0.57175
$ 137,220.78
Sales (Net of tax) = 2590000*(1-35%)
1 to 4
$ 1,683,500.00
2.85498
$ 4,806,356.07
Cost of Goods sold (Net of tax) = = 2590000*25%*(1-35%)
1 to 4
$ (420,875.00)
2.85498
$ (1,201,589.02)
Tax Saving on Depreciation = (3890000/4)*35%
1 to 4
$ 340,375.00
2.85498
$ 971,763.26
Net Present value (NPV)
$ 583,751.09
Calculation of NPV of the project:
Year
Cash Flows (CF)
PVF(15%)
PV = CF*PVF
Machine Cost
0
$ (3,890,000.00)
1.00000
$ (3,890,000.00)
Investment in net working capital
0
$ (240,000.00)
1.00000
$ (240,000.00)
Investment in net working capital recovered
4
$ 240,000.00
0.57175
$ 137,220.78
Sales (Net of tax) = 2590000*(1-35%)
1 to 4
$ 1,683,500.00
2.85498
$ 4,806,356.07
Cost of Goods sold (Net of tax) = = 2590000*25%*(1-35%)
1 to 4
$ (420,875.00)
2.85498
$ (1,201,589.02)
Tax Saving on Depreciation = (3890000/4)*35%
1 to 4
$ 340,375.00
2.85498
$ 971,763.26
Net Present value (NPV)
$ 583,751.09
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.