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 $1.998 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 $155,400. The project requires an initial investment in net working capital of $222,000. The project is estimated to generate $1,776,000 in annual sales, with costs of $710,400. The tax rate is 34 percent and the required return on the project is 13 percent.

-2,331,000

-2,109,000

-2,220,000

-1,998,000

-2,442,000

836,762

929,736

883,249

1,022,710

976,223

883,249

929,736

1,022,710

836,762

976,223

1,379,730

1,128,870

1,191,585

1,317,015

1,254,300

880,914

200,188

197,249

210,197

-426,678

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $1.998 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 $155,400. The project requires an initial investment in net working capital of $222,000. The project is estimated to generate $1,776,000 in annual sales, with costs of $710,400. The tax rate is 34 percent and the required return on the project is 13 percent.

Required: (a) What is the project's year 0 net cash flow?

-2,331,000

-2,109,000

-2,220,000

-1,998,000

-2,442,000

   (b) What is the project's year 1 net cash flow?

836,762

929,736

883,249

1,022,710

976,223

   (c) What is the project's year 2 net cash flow?

883,249

929,736

1,022,710

836,762

976,223

   (d) What is the project's year 3 net cash flow?

1,379,730

1,128,870

1,191,585

1,317,015

1,254,300

   (e) What is the NPV?

880,914

200,188

197,249

210,197

-426,678

Explanation / Answer

(a)

Year 0 cash flow = Cost of initial investment + Working capital

= - $ 1,998,000 - $ 222,000 = - $ 2,220,000

Hence option “3rd: - 2,220,000” is correct answer.

(b)

Depreciation = Cost of assets/useful life = $ 1,998,000/3 = $ 666,000

Annual sales

$         1,776,000

Less: Cost

$             710,400

Less: Depreciation

$             666,000

Gross profit

$             399,600

Less: Tax @ 34 %

$             135,864

Add: Depreciation

$             666,000

Net profit

$             929,736

1st year Net profit is Net cash flow. Hence option “2nd: 929,736” is correct answer.

(c)

Project’s year 2 net cash flow is same as year 1 net cash flow.

Hence option “2nd: 929,736” is correct answer.

(d)

Annual profit

$            929,736

Add: Working capital release

$            222,000

Add: Final market value of asset

$            155,400

Less: Tax @34% on Final market value

$              52,836

Net profit

$        1,254,300

After fully depreciation of the asset $ 155,400 has gained. So tax will imposed on the gain.

Project's year 3 net cash flow is $ 1,254,300.

Hence option “5th 1,254,300” is correct answer.

(e)

Year

Cash Flow

PV Factor Formula

PV Factor @ 13%

PV

0

($2,220,000)

1/(1+0.13)^0

1

($2,220,000)

1

929736

1/(1+0.13)^1

0.884955752

$822,775

2

929736

1/(1+0.13)^2

0.783146683

$728,120

3

1254300

1/(1+0.13)^3

0.693050162

$869,293

NPV

$200,188

Project's NPV at discount 13 % is $ 200,188.

Hence option “2nd: 200,188” is correct answer.

Annual sales

$         1,776,000

Less: Cost

$             710,400

Less: Depreciation

$             666,000

Gross profit

$             399,600

Less: Tax @ 34 %

$             135,864

Add: Depreciation

$             666,000

Net profit

$             929,736

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