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 $2.106 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 $163,800. The project requires an initial investment in net working capital of $234,000. The project is estimated to generate $1,872,000 in annual sales, with costs of $748,800. The tax rate is 33 percent and the required return on the project is 15 percent. Required: (a) What is the project's year 0 net cash flow? (Click to select) (b) What is the project's year 1 net cash flow? (Click to select) (c) What is the project's year 2 net cash flow? (Click to select (d) What is the project's year 3 net cash flow? (Click to select) (e) What is the NPV? (Click to select)

Explanation / Answer

Solution: a. The project's year 0 net cash flow = -$2,340,000 Working Notes: The project's year 0 net cash flow = Initial cost of fixed asset + initial investment in Net working capital = $2,106,000 + $ 234,000 =-$2,340,000 Negative as it is cash outflow b. The project's year 1 net cash flow = $984,204 Working Notes: The project's year 1 net cash flow =[(Sales - cost - depreciation) x (1-tax rate) + Depreciation ] = [((1,872,000 - 748,800 - (2,106,000/3))(1-0.33)) + (2,106,000/3)] =$984,204 c. The project's year 2 net cash flow = $984,204 Working Notes: The project's year 2 net cash flow =[(Sales - cost - depreciation) x (1-tax rate) + Depreciation ] = [((1,872,000 - 748,800 - (2,106,000/3))(1-0.33)) + (2,106,000/3)] =$984,204 Note: Year 2 Net cash flow will be same as it was in year 1 d. The project's year 3 net cash flow = $1,327,950 Working Notes: The project's year 3 net cash flow =[(Sales - cost - depreciation) x (1-tax rate) + Depreciation + Net working capital + Salvage value (1-tax rate)] = (((1,872,000 - 748,800 - (2,106,000/3))(1-0.33)) + (2,106,000/3) + $234,000 + 163,800(1-0.33)) =$1,327,950 e. NPV = $133,178 Working Notes: Year Cash flow PVF @ 15% Present value 0 -2,340,000 1              -2,340,000 1 984,204 0.869565             855,829.57 2 984,204 0.756144             744,199.62 3 1,327,950 0.657516             873,148.68 NPV                   133,178 Notes: PVF is calculated @ 15% = 1/(1+0.15)^n     where n is the period for which PVF is calculated. Please feel free to ask if anything about above solution in comment section of the question.

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