7.7 Summer Tyme, Inc., is considering a new 3-year expansion project that requir

Question

7.7

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $3.672 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $285,600. The project requires an initial investment in net working capital of $408,000. The project is estimated to generate $3,264,000 in annual sales, with costs of $1,305,600. The tax rate is 31 percent and the required return on the project is 15 percent.

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $3.672 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $285,600. The project requires an initial investment in net working capital of $408,000. The project is estimated to generate $3,264,000 in annual sales, with costs of $1,305,600. The tax rate is 31 percent and the required return on the project is 15 percent.

Explanation / Answer

a)Initial investment =Purchase cost+ investment in working capital

     = 3672000+408000

      =$ -4080000

correct option is "B

b_)Depreciation : 3,672,000/3 = 1224000

Annual net income after tax :[3264000-1305600-1224000][1-.31]

             = 734400*.69

             = 506736

cash flow = annual income after tax+depreciation

     = 506736+1224000 (non cash)

      = 1730736

correct option is "e" -1730736

c)correct option is "E" -1730736

d)After tax sale value: 285600[1-.31]=197064

Total cash flow for year3 = Operating cash flow +after tax sale value+working capital realized

          = 1730736 + 197064+408000

           = 2335800

correct option is " e"

e)Present value =[PVF15%,1*cf1]+[PVF15%,2*CF2]+[PVF15%,3*CF3]

    = [.86957*1730736]+[.75614*1730736]+[.65752*2335800]

    = 1504996.10+ 1308678.72+ 1535835.22

     = 4349510.04

NPV = 4349510.04-4080000

= $ 269510  

Correct option is "B" -269,499   [approx to 269,510]

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