Down Under Boomerang, Inc., is considering a new three-year expansion project th

Question

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.88 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $2,140,000 in annual sales, with costs of $835,000. The tax rate is 35 percent and the required return is 10 percent.

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.88 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $2,140,000 in annual sales, with costs of $835,000. The tax rate is 35 percent and the required return is 10 percent.

Explanation / Answer

Annual depreciation=$2.88million/3

=$960,000

Hence annual operating cash flows=(Sales-Costs)(1-tax rate)+Tax savings on Annual depreciation

=(2140000-835000)(1-0.35)+(0.35*960,000)

=$1184250.

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=$1184250[1-(1.1)^-3]/0.1

  =$1184250*2.486851991

=$2945054.47

NPV=Present value of inflows-Present value of outflows

=$2945054.47-$2,880,000

=$65054.47(Approx).

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