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 $5.9 million. The fixed asset falls into the 3-year MACRS class (MACRS Table) and will have a market value of $462,000 after 3 years. The project requires an initial investment in net working capital of $660,000. The project is estimated to generate $5,280,000 in annual sales, with costs of $2,112,000. The tax rate is 34 percent and the required return on the project is 14 percent. (Do not round your intermediate calculations.)

(a) What is the project's year 0 net cash flow? (b) What is the project's year 1 net cash flow? (c) What is the project's year 2 net cash flow? (d) What is the project's year 3 net cash flow? (e) What is the NPV?

Explanation / Answer

The net cash flows are provided in the table below

Note** NPV is computed using the NPV function as =NPV(14%, cash flows from years 1-3)+ Cash flows of year 0

Firstly, we assume that the working capital will be recovered in year 3.

WORKING NOTE 1

Annual income from operations without considering depreciation is calculated as follows

WORKING NOTE 2

Depreciation schedule is as follows

WORKING NOTE 3

Book value at the end of year 3 = $437,190

Sale value = 462000

Capital gain = 462000-437190 = $24,810

Tax on capital gain = 34%*24810 = 8435.40

Year Initial investment Salvage value post tax Working capital Post tax Operating Income Tax saving on depreciation Net cash flows 0 $(5,900,000.00) -660000 $(6,560,000.00) 1 2090880 $     668,599.80 $ 2,759,479.80 2 2090880 $     891,667.00 $ 2,982,547.00 3 $ 453,564.60 660000 2090880 $     297,088.60 $ 3,501,533.20 NPV $     519,004.56

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